Retirement and Investment Webinar Series

Transcription

1 Retirement and Investment Webinar Series October 14, 2015 Retirement and Investment

2 Year-End Retirement Planning Financial Issues and Opportunities Joan Boughton Eric Keener Dan McFall Alan Parikh Brian Walker Retirement and Investment

3 Agenda Slide Section 1 Section 2 Section 3 Section 4 Spot Rate Approach to Measuring Benefit Cost Case Study: AT&T Retirement Age Trends Longevity Trends and Other Assumptions Retirement and Investment 3

4 Spot Rate Approach to Measuring Benefit Cost Retirement and Investment 4

5 Alternative Approaches for Measuring Benefit Cost Traditional Approach Spot Rate Approach (Used by AT&T, calling it full yield curve approach) Plan sponsors using a corporate bond yield curve approach to measure their benefit obligations disclose a single equivalent discount rate that produces the same obligations as the full yield curve The same single weighted average discount rate is used to calculate: Service Cost Interest Cost on the benefit obligation Alternative concept evolved at over past several years, emerging from our significant de-risking experience Discount rate assumption is viewed as the full yield curve rather than the single equivalent rate, so each spot rate along the yield curve is applied to each corresponding benefit cash flow More granular interest cost computation, grounded in accounting literature s requirement to accrue interest cost at rates equal to the assumed discount rates Service Cost more precisely determined based on durationspecific spot rates applied to the service cost cash flows No change to the benefit obligation Retirement and Investment 5

6 Determining Interest Cost: Comparing Two Yield Curve Approaches PBO (in $millions) $600 $500 $400 $300 $200 $100 Spot Rate Approach 2 PBO-Weighted Average Interest Cost Rate of 3.62% $ Effect of Discounting Yield Curve 1 Traditional Approach Aggregated Discount Rate of 4.33% PBO (PV of cash flow) Single Equivalent Rate 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Discount Spot Rate Observations on Spot Rate Approach With upward sloping yield curve, spot rate method reduces current period service and interest cost For a plan with PBO of $1B, we typically see a reduction of $6-9M in interest cost Impact will vary based on shape of the corporate bond yield curve and duration of the liability Differences between the two approaches flow into future accounting periods reducing the gain (increasing the loss) 1 yield curve, AA Above Median, December 31, 2014, used by XYZ Company Pension Plan. 2 Interest cost developed by applying each spot rate in the full yield curve to the present value of the cash flow corresponding to that rate. Retirement and Investment 6

7 Plan Sponsor Considerations SEC Perspective In discussions with the Big Four auditing firms in September 2015, the SEC Staff indicated that: They would not object to: Use of the spot rate approach Treating a change in approach as a change in estimate applied prospectively Companies should discuss appropriate, robust disclosures with their auditors Viewed as a one-way change since approach is presumably considered more precise Companies may continue to use Traditional Approach since ASC 715 explicitly allows for an aggregate average rate Accounting Firm Acceptance PwC, KPMG, Deloitte, and EY bulletins are consistent with SEC perspective Expect any change at next formal measurement date Generally seem to expect consistent application to all defined benefit plans under ASC 715 Application to bond matching model : Companies should discuss with their actuaries, auditors, and review intended changes with SEC staff Retirement and Investment 7

8 Back Testing Analysis of Interest Cost Shows Volatility ABC Retirement Plan ($1B PBO) Estimated Reduction in Interest Cost Relative to Traditional Approach Curve Flattened $ Millions Inverted Treasury Curve 12/31/2006 Flat Corporate Bond Curve 12/31/08 Reduction in Interest Cost Fiscal Year Equivalent Discount Rate % Spot Rate Interest % Reduction % Retirement and Investment 8

9 Prevalence of Inverted Yield Curve Frequent question when considering changes to the Spot Rate Interest Cost: How often does the yield curve invert? Treasury curve AA corporate bond curve Inverted ~19% of days since 1962 but only rarely since the early 1980s Inverted ~9% of days since 1973 Retirement and Investment 9

10 Spot Rate Interest Cost Sensitivity Analysis Real issue for plan sponsors might not be inverted yield curves, but just changes in the slope of the yield curve from measurement date to measurement date Changes in slope of yield curve can lead to additional volatility for future year-over-year expense Unpredictability ABC Retirement Plan Traditional Interest Cost Estimated Impact on FY16 to FY17 Expense 0.25% d-rate decrease $6M increase 0.25% d-rate increase $5M decrease Flatter curve creates headwind Spot Rate Interest Cost Estimated Impact on FY16 to FY17 Expense PBO Discount Rate Yield Curve Slope ABC Retirement Plan 0.25% flatter No Change 0.25% steeper -0.25% No change +0.25% +$13M +$6M $0 +$6M $0 -$5M $0 -$6M -$12M Rising rates and flatter curve can be offsetting factors for companies that amortize gain/loss Retirement and Investment 10

11 Considerations in Adopting the Yield Curve Alternative Potential Concerns Potentially higher expense if corporate bond yield curve becomes inverted Increased year-over-year volatility as yield curve changes May be more difficult to budget pension expense, creating more variance between budgets and actual results Lower settlement threshold (when Interest Cost and Service Cost are lower) Feasibility and impact for non-u.s. plans Comparability with other companies May impact compensation or reward elements tied to certain earnings measures Robust disclosures needed Bond matching models SEC staff did not provide their views related to the bond matching approach and application of spot rates to estimate service cost and interest cost Need to weigh potential benefit of more precise measurements against potential risk of higher volatility year-over-year Retirement and Investment 11

12 Bond Matching Models SEC has not provided their views related to bond matching model believes that the bond matching approach and the full yield curve approach are fundamentally the same since follow from same accounting guidance: Select individual spot discount rates with respect to year-by-year cash flows Spot discount rates are the yields from the bond portfolio that can settle the cash flows; accounting literature mentions two cases Spot rates embedded in the PBO measurement should arguably be used in the computation of service and interest cost in the disaggregated approach Yield Curve Cash-matched zero coupon hypothetical portfolio covering each maturity date PBO = Fair value of bond portfolio that settles cash flows Bond Matching Model Not cash-matched portfolio of select bonds which do not cover each maturity date ASC Full yield curve represents yields on hypothetical portfolio Spot discount rates = bond yields Spot discount rates = bond yields supplemented with extrapolated spot rates Incorporate reinvestment rates for excess cash in-flow Traditional single rate approach (IRR of bond portfolio) Spot rate approach for SC + IC Practical expedient traditionally used Traditional single rate approach (IRR of bond portfolio) Retirement and Investment 12 Spot rate approach for SC + IC

13 Case Study: AT&T Retirement and Investment 13

14 Case Study: AT&T Inc. Background Historically AT&T used the traditional approach to determine Service Cost and Interest Cost for its pension and OPEB plans AT&T applies mark-to-market accounting such that gains and losses are recognized in the current period Change First adopter of the spot rate approach beginning in Q following an interim remeasurement No change in total expense due to mark-tomarket accounting More precise measurement which improved the allocation of expense to appropriate reporting periods and entities No change in total expense under mark-tomarket First adopter of the spot rate approach in Q Recognition Considered this a change in accounting estimate that is inseparable from a change in accounting principle Recognized prospectively per ASC EY issued a preferability letter which was included with the10-k filing Retirement and Investment 14

15 Retirement Age Trends Retirement and Investment 15

16 Longevity and Retirement Age Assumptions Longer life expectancy Later retirement ages Steady increases in life expectancy Advances in treatment of heart disease and cancer, public health improvements, smoking cessation Further improvements expected Notable increase in retirement age since 2000 Social Security changes, decline in defined benefit and postretirement medical plans, low interest rates, and healthier older workers Factors have not yet run their course Retirement ages expected to rise further Retirement and Investment 16

17 Actual Retirement Ages Have Increased Since 2005, the average age at which people retire has increased by about 1.4 years Sharp rise in people waiting until age to retire (20.6% in 2005 to 33.5% in 2013) 66 Average Age at Retirement believes that retirement ages will continue to rise across a wide range of industries and companies Total Women Men Source: Author calculations using the Current Population Survey Retirement and Investment 17

18 Key Drivers of Rising Retirement Ages Social Security Retirement income shortfalls Demographic shifts Structural shifts Full eligibility age rising to 67 by 2027, from 65 in 2002 and 66 today Delayed Retirement Credit (DRC) fully phased in since 2009 Rising longevity makes DRC increasingly valuable Decline in DB and retiree medical coverage Low interest rates Rising longevity Some industries struggling to retain workers Shift to later career starts Takes longer to achieve median wage than in previous decades Improved health status Greater automation of routine and physically demanding tasks Specialized skills, experience more critical than ever before Retirement and Investment 18

19 Traditional Retirement Triggers are Disappearing Defined Contribution Triggers Less Likely to Drive Behavior than DB Value of Retirement Benefit 62 Unreduced 65 Normal Retirement Value of Retirement Benefit as % Pay Defined Benefit Defined Contribution 55 Early Retirement and separation from service 70.5 Required Minimum Distributions Age Retirement and Investment 19

20 Why Retirement Age Assumptions Matter Typical Impact Greater Assumed Longevity Rising Assumed Retirement Ages Accounting Higher pension expense Higher balance sheet liability Lower pension expense Lower balance sheet liability Cash Contributions PBGC Variable Rate Premiums No impact until IRS revises mortality tables (perhaps by 2017) No impact until PBGC adopts updated mortality tables for Variable Rate premium calculation Lower required contributions Lower PBGC Variable Rate premiums Retirement and Investment 20

21 Will Retirement Ages Continue to Rise? Questions for Plan Sponsors Are a greater proportion of employees working to 65 or even later? Has this trend continued or even accelerated in the past few years? Retirement Experience Study Plan Design Are your defined benefit plans closed or frozen? Have you cut back your postretirement medical plans? Workforce Dynamics Are you experiencing labor shortages in key functions as the boomer retirement wave hits? Are you escalating efforts to retain workers with key skill sets? Do projections show a rising number of retirements over the next five to ten years? Retirement and Investment 21

22 Longevity Trends and Other Assumptions Retirement and Investment 22

23 SOA Issues Updated Mortality Improvement Assumptions On October 8, 2015 the Society of Actuaries (SOA) released updated mortality improvement assumptions for retirement plans (MP-2015) Reflects additional data that Social Security Administration has released since prior assumptions (MP-2014) were developed Data shows lower mortality improvement in than in previous years Results in lower projected future improvements in SOA model Key question: Does data indicate a new long-term trend? Or just random noise? SOA expects to: Release annual updates going forward Explore availability of more current information to decrease lag time Issue next update in mid-2016? MP-2015 produces 1-2% Typical reduction in plan liability vs. MP-2014 Retirement and Investment 23

24 Actual Mortality Improvement Can Be Very Volatile from Year to Year Retirement and Investment 24

25 Updated Mortality Improvement Assumptions Next Steps for Plan Sponsors Plan sponsors should consider reflecting new data in 2015 year-end disclosures and 2016 expense Could use MP-2015 or an alternative assumption If reflect new data this year, auditors may expect annual updates going forward as new data is released Could result in additional volatility Future updates could increase plan liabilities if mortality improvement is greater than expected Key Takeaways MP-2015 produces lower liabilities than MP-2014 Consider reflecting in 2015 disclosures and 2016 expense Note potential for added volatility going forward Retirement and Investment 25

26 Other Assumption Considerations Continued trend toward lower rates For typical plan, up ~35 bp 9/30 Yield curves have steepened Discount Rates EROA Active Alpha Consider explicit assumptions for active alpha AHIC develops based on buyrated manager performance Medical Trend In recent years, higher Rx and lower medical Can vary significantly based on plan provisions Retirement and Investment 26

27 Questions and Answers with questions for our speakers. Retirement and Investment 27

28 Speaker Biographies Joan Boughton Eric Keener Dan McFall Joan is an actuary and Partner at the firm, co-leading s national Retirement Strategy and Design / IDEA team. She consults on HR and retirement strategy, design, implementation, administration, communication, financing, and ongoing plan management. Eric is a Partner and Chief Actuary of 's U.S. Retirement Practice. He leads our National Actuarial Resource Team and is responsible for delivering training, thought leadership, technical guidance, and day-to-day assistance to our consultants as they serve our clients. He also consults with several large clients on a broad range of retirement plan issues. Dan is an actuary and Partner with. He is one of s thought leaders and consults with some of our largest retirement clients on retirement strategy, design, financing, and ongoing plan management. Alan Parikh Brian Walker Alan is a member of s National Actuarial Resource Team, helping consultants deliver quality work and value-added consulting across the United States. He is also a member of Pension Committee of the Actuarial Standards Board, a CFA charterholder, and CAIA charterholder. Brian is an actuary and Associate Partner in s Retirement and Investment practice. He advises clients on funding and accounting requirements for their retirement programs, and provides strategic advice on retirement plan design, executive retirement benefits, postretirement benefits, and plan administration. Retirement and Investment 28

29 About empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information, please visit aonhewitt.com. Aon plc All rights reserved. Retirement and Investment 29