Preview of 2014 Lump Sum Interest Rates

As mentioned in our July lump sum interest rate post, many defined benefit (DB) plan sponsors are considering lump sum payouts to their terminated vested participants as a way of “right-sizing” their plan. The ultimate goal is to reduce plan costs and risk. The IRS recently released the November 2013 417(e) rates, which will be the 2014 reference rates for many DB plans. This post shares a brief update of the impact these rates could have on 2014 lump sum payout strategies.

Background
DB plans generally must pay lump sum benefits using the larger of two plan factors:

(1)  The plan’s actuarial equivalence; or
(2)  The 417(e) minimum lump sum rates.

Since interest rates have been so low over the past few years, the 417(e) rates are usually the lump sum basis. In particular, 2013 lump sums were abnormally expensive due to historically low interest rates at the end of 2012 (the reference rates for 2013 lump sum calculations). This is because lump sum values increase as interest rates decrease and vice versa.

Effect of Interest Rate Changes
For calendar year plans, the lookback month for the 417(e) rates is often a couple of months before the start of the plan year. Here’s a comparison of the November 2012 rates (for 2013 payouts) versus the November 2013 rates (for 2014 payouts).

November 2013 segment rate table

As we can see, all three segments have increased substantially since last November. So, what’s the potential impact on lump sum payments? The table and chart below show the difference in lump sum value at sample ages assuming payment of deferred-to-65 benefits using the November 2012 and November 2013 417(e) interest rates.

November 2013 lump sum chart

November 2013 lump sum table

Note: If we adjust for the fact that participants will be one year older in 2014 (and thus one fewer years of discounting), then this decreases the savings by about 5% at most ages.

Lump Sum Strategies
So, what else should plan sponsors consider?

1. If you haven’t already considered a lump sum payout window, the 2014 lump sum rates may make this option much more affordable than in 2013.

2. With the scheduled increase in PBGC flat-rate and variable-rate premiums due to MAP-21 (plus the proposed additional premium increases in the Bipartisan Budget Act of 2013) there’s an incentive to “right-size” a pension plan to reduce the long-term cost of PBGC premiums.

3. In addition to lump sum payout programs, plan sponsors should consider annuity purchases and additional plan funding as ways to reduce long-term plan costs/risks

Lump Sum Interest Rate Update – June 2013

Many defined benefit (DB) plan sponsors are considering lump sum payouts to their terminated vested participants as a way of reducing plan costs and risk. This post shares a brief update of the interest rates used to calculate deferred vested lump sums and the impact it could have on potential lump sum payout strategies.

Background
DB plans generally must pay lump sum benefits using the larger of two plan factors:

(1)  the plan’s actuarial equivalence; or
(2)  the 417(e) minimum lump sum rates.

Since interest rates have been so low over the past few years, the 417(e) rates are usually the lump sum basis. This means that lump sums are at historically high levels since lump sum values increase as interest rates decrease (and vice versa). Plan sponsors need to consider whether the recent increase in 417(e) interest rates will materially decrease lump sum values and make it worthwhile to postpone a lump sum program until 2014 if it means that lump sums will be “cheaper” then.

Effect of Preliminary Interest Rate Changes
For calendar year plans, the lookback month for the 417(e) rates is often a couple of months before the start of the plan year (e.g., the November rates). Here’s a brief comparison of the November 2012 rates (for 2013 payouts) versus the June 2013 rates (i.e., what rates might look like for 2014 payouts).

June 2013 segment rate table

As we can see, all three segments have increased since last November. So, what’s the potential impact on lump sum payments? The table and chart below show the difference in lump sum value at sample ages assuming payment of deferred-to-65 benefits using the November 2012 and June 2013 417(e) interest rates.

June 2013 lump sum chart

June 2013 lump sum table

Note: If we adjust for the fact that participants will be one year older in 2014 (and thus one fewer years of discounting), then this decreases the savings by about 5% at most ages.

Lump Sum Strategies
So, what should plan sponsors consider?

1. If you’re in the process of implementing a 2013 lump sum payout window for terminated vested participants, you may want to consider the potential savings of waiting until 2014 to pay benefits.

2. There’s no guarantee that interest rates will remain higher until your plan locks-in its lump sum rates later this year. Rates could go up or down, so you’ll need to consider whether you can handle the risk and cost if interest rates go back down and lump sum values increase.

3. Even if you’ve started the process of preparing for a 2013 lump sum window, it’s not a wasted effort if you decide to wait until 2014. Work spent tracking down missing participants, finalizing accrued benefit calculations, and drafting plan amendments needs to be done anyways. However, you’ll want to set a firm “go” or “wait” deadline so there’s enough time to complete the project in 2013 if you desire.

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.

Update: the retiree health reinsurance gold rush

Last week, the HHS published an interim final rule for the new Early Retiree Reinsurance Program (should we call it ERRP?).

In our first post on this, we noted that a lot was still unknown.  There still is, but it’s becoming clearer.

The White House fact sheet says “Employers can use the savings to either reduce their own health care costs, provide premium relief to their workers and families or a combination of both”.  But §149.40 of the rules says that the application must also specify “How the sponsor will use the reimbursement to maintain its level of contribution to the applicable plan”.

I’ve had a tough time reconciling those two, but the HHS helps us out:  “For example, for a sponsor that pays a premium to an insurer, if the premium increases, program funds may be used to pay the sponsor’s share of the premium increase from year to year, which reduces the sponsor’s premium
costs.”  For big plans, that premium increase can be a lot of money.

The retiree health reinsurance gold rush

There’s an intriguing provision in the new health care reform law for retiree medical plans:  80% reinsurance for each early retiree’s claims between $15,000 and $90,000.  The official summary is here.

There’s a fixed amount of money available for this, just $5 billion.  When it’s gone, it’s gone.  And remember that $5 billion doesn’t go as far as it used to, so you gotta get in line right away.  The application will be available in June, and it will be a lot like the one for Medicare Part D’s Retiree Drug Subsidy program.

Of course there’s a catch:  your retiree medical plan needs certain cost saving provisions to qualify.  It’s not clear yet what those should be. Actually, there’s a lot that’s not clear yet.  But it sure looks like a sweet deal, so it’s worth a look.

It will reduce OPEB costs for public and private employers, and for their plan members.  Exactly how much will depend on your own retiree health plan provisions.