Pension Discount Rates – September 2013 Preview

After several years of painfully-low pension discount rates, we’ve seen a modest rebound in 2013. Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates are up by about 80 basis points so far this year.

This is great news for pension plan sponsors, especially if rates continue their upward trend. Add in strong year-to-date equity returns, and we may finally see a reduction in unfunded pension balance sheet liability for fiscal year-end 2013.

Analysis
In the chart below we compare the CPDC at four different measurement dates (12/31 2010 to 2012, and 8/31/2013). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.

Citigroup comparison 08312013

Rates have increased at all points along the spectrum since 12/31/2012. The orange arrows highlight the trend in yield curve movement. The increase in rates all along the yield curve means that all types of plans (e.g., frozen and open) should benefit if interest rates continue to increase through year-end.

Net Effect on Balance Sheet Liability
Many plans had strong investment returns during the first half of the year, with some fluctuations over the past couple of months. If those early investment gains can be preserved (or increased) until year-end, then this will further improve the pension funded status (assets minus liabilities). Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported balance sheet liability.

Conclusions
So, what should plan sponsors be considering over the next few months as we approach year-end? Here are a few ideas.

  • Don’t count your chickens before they hatch. We’re still several months away from year-end for most plans and a lot can change between now and then. However, there’s reason to be cautiously optimistic.
  • Now maybe a good time to consider strategies that lock-in some of this year’s investment gains. These could include exploring an LDI strategy to more closely align plan assets and liabilities. Or, offering a lump sum payout window for terminated vested participants early in 2014.
  • Even though increased discount rates tend to lower the present value of pension liabilities, your plan may still have an overall liability increase. This could result from active participants continuing to accrue new benefits in the plan, or from the fact that benefits will have one fewer year of interest discount at 12/31/2013 compared to 12/31/2012.

Your plan’s specific cash flows could have an enormous impact on how much the drop in discount rates affects your pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC or an alternative index or yield curve to see how it stacks up.

Public Safety Benefits Can Significantly Affect OPEB Liabilities

Federal, state and local regulations often include mandated health benefits for officers disabled in the line of duty. These benefits are a way to reward officers for protecting and serving the public at great risk of bodily harm. The value of these benefits must be accounted for under GASB accounting rules, and there are a few important considerations when doing so.

Important considerations for OPEB plans:

– Determining the implicit rate subsidy (health cost in excess of the average premium). This may include expected health care costs for disabled officers that are significantly higher than for non-disabled individuals.  Another factor to consider is whether or not disabled officers are Medicare-eligible. If so, how does that reduce the expected health care costs?

– Determining the direct subsidy (portion of the premium paid by the employer).  This is the premium cost not only for disabled officers, but also for dependents.

– Length of benefit coverage. Unlike regular retiree health care which can begin around age 50 to 55 for officers, disability health care begins much earlier.  Often officers disabled in the line of duty are in their 30’s and 40’s.

The earlier start creates significant additional costs.  For example, the direct subsidy for a disabled officer age 40 could exceed $150,000 ($6,000 in premium per year for 25 years) – and this does not include any costs for dependent coverage or the implicit subsidy. Read more…

OPEB Participation Rates – “Kind of a Grey Area” Under Healthcare Reform

One of the highest impact assumptions in OPEB actuarial valuations is the participation rate.  This rate represents the percent of future retirees assumed to participate in the employer’s health plan during retirement.

The participation assumption has a direct and leveraged effect on OPEB liabilities.  For example, if the assumption is that 60% of employees are assumed to elect coverage at retirement, but the actual “crystal ball” rate is 40%, then the plan’s liability is 1½ times what it should be.  As a result of healthcare reform, similar examples may become a reality that employers and actuaries should address proactively. 

How will healthcare reform affect participation rates?  That’s kind of a grey area.  How grey?  “Charcoal” as Fletch would say.

Participation rates will be different in the future due to anticipated cost-saving changes to retiree plans by employers.  Recently, 61% of the companies included in an Aon Hewitt survey were either already evaluating or expected to evaluate their long-term retiree medical strategy by the end of 2011.

Read more…

How will the “Cadillac Tax” impact your OPEB plan?

 Although the effect of healthcare reform on retiree health plans is difficult to gauge at this point, there are several provisions that could impact the long-term costs   and strategies for employer plans. Let’s start with the so-called “Cadillac Tax” on high-cost insurance plans effective in 2018.

 What it is:

 A non-deductible 40% excise tax paid by the coverage provider (employer and/or insurer) on the value of health plan cost in excess of certain thresholds. Currently, most plans are well below the thresholds, but are likely to exceed them in the next decade. This is because the thresholds will be indexed at CPI-U which is significantly lower than medical inflation rates affecting plans.

Purpose of the provision:

One of the goals of the Patient Protection Affordable Care Act (PPACA) was to lower long-term healthcare costs. By their nature, plans with generous benefits implicitly encourage participants to maximize their usage and thus cause higher medical costs. This provision seeks to discourage high-cost plans by leveling a tax on “excessive” benefits and possibly help fund healthcare reform.

Important considerations for retiree health plans:

Health plan costs for early retirees, which are often significantly higher than employee costs, may exceed their thresholds sooner, even though thresholds for early retirees are slightly higher than thresholds for employees. Read more…

Start Thinking About the Impact of Medicare Reform on OPEB Plans

Employers who offer retiree health benefits to their employees have something new to think about: How will proposed Medicare reforms impact my plan and its costs? Although changes to the Medicare system are likely a long way off, Medicare reform is a hot topic lately and changes to the program could have a dramatic effect on your retiree obligations if you aren’t prepared for it.

A recent Governing article provides a good summary of the relevant issues for public employers. Many of these ideas are equally applicable to private sector retiree health and OPEB plans. I thought it would be useful to summarize some of these points and add a couple of other considerations.

– If a retiree medical plan offers post-65 coverage to retirees, it is often through a Medicare supplement plan which just pays costs that aren’t covered by Medicare. If Medicare payments for benefits decrease, then this will increase the costs paid by the employer plan. Read more…

It’s now or never for ERRP application

We all knew this day would come, and now it’s here.  New applications for the Early Retiree Reinsurance Program (ERRP) will be received only until 5 pm on Thursday, May 5th.

The last time we blogged about this, the ERRP money was going fast.  Now the urgency is clear.

So if you’ve been thinking about applying, it’s now or never.   Elvis says so.

ERRP update: it’s time to make your move

In our last ERRP post, we noted that $1 billion of the original $5 billion in Early Retiree Reinsurance Program (ERRP) funds has been paid out.  Now, according to an article this week in Business Insurance, the US Dept of Health and Human Services (HHS) estimates that $3.6 billion will have been paid out in fiscal 2011 (ending 9/30/11).  That leaves only $1.4 billion for next year – and then it’s gone.

So, if you’re thinking about applying, it’s time to make your move.  The application process isn’t as bad as it initially appeared.  Our last ERRP post outlines how to go about it.

Understanding the Leveraging Effect of GASB 45 OPEB Liabilities

As public plan sponsors complete their second (or third) actuarial valuation of GASB 45 liabilities, they may be surprised at the potential volatility of their Actuarial Accrued Liability (AAL). There are various factors that can cause large AAL changes, including adjustments to the plan provisions or switching health insurers. This post focuses on a less obvious (though sometimes more powerful) source: the leveraged nature of OPEB liabilities.

The retiree healthcare promises measured under GASB 45 generally consist of two pieces: a gross health claims component (i.e., the expected cost of retiree health coverage) and a premium offset component (i.e., the amount that retirees pay for their coverage). The net OPEB liability is just the difference between these two elements. The following example illustrates how a small change in either of the input components can have a much larger effect on the net liability result. We call it the “leveraging” effect.

Read more…

ERRP funds are going fast, but employers still have time to act

$1 billion of the original $5 billion has now been paid out under the Early Retiree Reinsurance Program (ERRP), according to an article this month in Business Insurance.

We’ve been watching the ERRP since its inception (posts 1, 2, 3, 4), and didn’t think the $5 billion allocation would last long. A July 2010 EBRI article estimated that it would last two years – and it might go even faster than that.   The EBRI article estimates the average reimbursement at about $2,000 per early retiree (Figure 4 on page 5: $2,544m / 1.3m = $1,957) – but there can be huge variations for  your own retiree group.

Many of our clients have applied for the ERRP and have been accepted. For employers that haven’t yet, there’s still time.  And the application process isn’t as onerous as it initially appeared.

Here’s what you need to do:

1. Check with your health insurer to see if you’re likely to have any individual early retiree claims above $15,000.  For midsize and large public-sector employers in Minnesota, Iowa, Indiana and Florida it’s almost a given – because subsidized early retiree coverage (the GASB 45 implicit rate subsidy) is mandated in those states.

2. Fill out and submit the ERRP application. Your health insurer can help with the trickiest parts of the application, i.e. cost control provisions and estimated reimbursements.

3.  Once your application is approved, follow the process on the ERRP website to obtain reimbursements. Your health insurer will have an important role in the reimbursement process, since you won’t usually know when you have an eligible claim.

 

$1 billion has now been paid out under the Early Retiree Reinsurance Program (ERRP), according to an article this month in Business Insurance http://www.businessinsurance.com/article/20110105/BENEFITS06/110109965.
We’ve been watching the ERRP since its inception (link to previous posts), and didn’t think the $5 billion allocation would last long.  A July 2010 EBRI article http://www.ebri.org/pdf/notespdf/EBRI_Notes_07-July10.Reins-Early.pdf estimated that it would last about two years – but it might go faster than that.

 

 

Many of our clients have applied for the ERRP and have been accepted.  For employers that haven’t yet, there’s still time.  And the application process isn’t as onerous as it initially appeared.
Here’s what you need to do:
1.  Check with your health insurer to see if you’re likely to have any individual early retiree claims above $15,000.  For midsize and large government employers in Minnesota, Iowa, Indiana and Florida it’s almost a given – because subsidized early retiree coverage (the GASB 45 implicit rate subsidy) is mandated in those states.
2.  Fill out the ERRP application www.errp.gov/download/ERRP_Application.pdf.  Your health insurer can help with the trickiest parts of the application, i.e. cost control provisions and estimated reimbursements.  The EBRI article http://www.ebri.org/pdf/notespdf/EBRI_Notes_07-July10.Reins-Early.pdf estimates this at about $2000 per early retiree (Figure 4 on page 5:  $2,544m / 1.3m = $1,957) – but there can be huge variations depending on your own retiree group.
3.  Once your application is approved, follow the process on the ERRP website www.errp.gov/index.shtml to obtain reimbursements.  Your health insurer will have an important role in the reimbursement process, since you won’t usually know when you have an eligible claim.

PPACA Starting to Impact Retiree Health Plans

In the retiree benefits world, there is a general consensus that several provisions in the Patient Protection and Access to Care Act (PPACA) may cause employer sponsors of retiree health plans to rethink those programs. These changes include:

– Filling of the Part D “doughnut hole” (2010-2020)

– Guarantee issue insurance with no pre-existing condition exclusions (2014)

– Health insurance exchanges (2014)

These reforms, along with others, will potentially make it less expensive for a retiree to get coverage on the “open market” rather than through their employer-sponsored program. This could be especially true if the retiree only has access to the employer plan and is paying the full premium for coverage.

As reported in the Minneapolis StarTribune recently, 3M is one of the first large employers to disclose that they plan to end their retiree health plan because they feel retirees will likely be able to get better coverage for a lower price under the PPACA reforms. Whether this is a bellwether remains to be seen.

However, the decision to end a retiree health program in anticipation of the full effect of health care reform raises some important issues:

– For retirees who have been on the employer plan for many years, how are they being prepared to “go into the market” and select health insurance?

– If the PPACA provisions are modified or repealed before they fully go into effect, how will this change the insurance options (and costs) for retirees whose employers have decided to eliminate their retiree health plans?

– Would an employer consider reinstating their retiree health plan if PPACA is repealed?