SOA 2012 Annual Meeting & Exhibit October 14-17, Session 114 PD, Rapid Retirement Research. Moderator: Andrew J. Peterson, FSA, EA, FCA, MAAA

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1 SOA 2012 Annual Meeting & Exhibit October 14-17, 2012 Session 114 PD, Rapid Retirement Research Moderator: Andrew J. Peterson, FSA, EA, FCA, MAAA Presenter: Joseph J. Silvestri, FSA, EA, FCA, MAAA Primary Competency Results-Oriented Solutions

2 RAPID RETIREMENT RESEARCH: PROVIDING AN ACTUARIAL PERSPECTIVE ON SMOOTHING AND OTHER ISSUES Moderator: Andrew Peterson, FSA, EA, FCA, MAAA Presenter: Joseph Silvestri, i FSA, EA, FCA, MAAA Primary Competency: Primary Competency: Results-Oriented Solutions AGENDA What is Rapid Retirement Research? The Rising Tide of Pension Contributions Pension Funding Stabilization Preview of Next Report: Comparison of Input and Output Smoothing The Future of the Initiative 1 1

3 WHAT IS RAPID RETIREMENT RESEARCH? A two-year pilot program investigating the SOA s potential for providing timely, objective, data-driven research to the public and policy makers Opportunity to promote the actuarial profession among the public For pilot, research focused on U.S. private defined benefit (DB) system 2 FULFILLING THE SOA MISSION From the Mission and Vision statement: ( Research Organization Serving the Public Recognition as the Leading Professionals Critical Success Factors: Be relevant to the needs of our customers. Have an effective influence on public policy. 3 2

4 THE FIRST YEAR Established the function and published the first report Set up Modeling Oversight Group (MOG) Acquired data and modeling system (PIMS) and learned how to use it Published report in October, 2011: The Rising Tide of Pension Contributions ( 4 THE RISING TIDE An system-wide analysis of cash contributions to U.S. private single-employer DB plans Followed two major events affecting the system: Implementation of the Pension Protection Act Financial crisis of 2008 Projected future contribution requirements Provided historical contribution levels for context 5 3

5 HISTORICAL CONTRIBUTIONS For the ten years ending with 2009: Actual contributions tions averaged about $66 billion per year Minimum required contributions fluctuated between $9 billion and $22 billion Excluding the credit balance, the minimum required ranged from $19 billion to $67 billion Actual contributions ranged from $19 billion to $91 billion 6 HISTORICAL CONTRIBUTIONS Source: The Rising Tide of Pension Contributions Post-2008: How much and when? 2011 Society of Actuaries, Schaumburg, Illinois 7 4

6 PROJECTED CONTRIBUTIONS For the ten years beginning with 2010, we projected: Required contributions would average $90 billion per year Actual contributions would exceed the requirements, particularly in 2010 and 2011 Contribution requirements would peak at about $140 billion in 2016, if only required amounts were contributed 8 PROJECTED CONTRIBUTIONS Source: The Rising Tide of Pension Contributions Post-2008: How much and when? 2011 Society of Actuaries, Schaumburg, Illinois 9 5

7 IMPLICATIONS Little effect on corporate earnings Large effect on corporate cash Sponsors are anticipating increase, but magnitude is uncertain Degree of stress will differ Risk profile of plan sponsors varies Effect on plan participants is uncertain 10 POTENTIAL COURSES OF ACTION Status Quo Sponsor Strategy Fund obligations in advance of requirement and use credit balance Reduce future accruals De-risk plan investments Regulator Strategy Revise the minimum required contribution Encourage de-risking 11 6

8 ONE MORE POTENTIAL COURSE Sponsor Strategy: Request Relief Sponsors may request hardship relief from IRS Waiver process is not commonly known, generally slow, and seldom used in past due to apparent difficulty to qualify Sponsors could possibly seek additional legislative relief 12 RAPID RESEARCH - THE SECOND YEAR Research agenda: Update to the Rising Tide study Comparison of input and output smoothing techniques Effects of the low interest rate environment Monitoring of legislative developments for research opportunity 13 7

9 EVENTS IN WASHINGTON November, 2011 Industry coalition proposes revisions to U.S. funding law: Valuation discount rates limited it to within 10% of a 25-year historical average Extended amortization of gains/losses February, 2012 U.S. Senate amends transportation bill to include Pension Funding Stabilization provisions Modified the rate collar 15% range and 10-year average Excluded amortization proposal March, 2012 U.S. Senate passes Moving Ahead for Progress in the 21 st Century (MAP-21) bill Rate collar based on a 25-year average Collar expands from 10% in 2012 to 30% in 2016 and beyond 14 SOA ACTS Public legislative proposal with actuarial implications Demand for data Related to then current project Framework established Reviewers already recruited Published report in June, 2012: Proposed Pension Funding Stabilization ( 15 8

10 FUNDING STABILIZATION REPORT Framework based on principles published by the American Academy of Actuaries in 2005 ( We adopted three principles for the analysis: Solvency Assets should cover the market value of accrued benefit liabilities within a reasonable time period. Predictability Contributions should be more predictable so they can be budgeted in advance. Transparency Information about the financial position of the plan should be understandable to users. 16 EFFECT ON VALUATION INTEREST RATES Comparison of Effective Interest Rates (EIRs), assuming constant future spot curve: Valuation year Current law interest rate 5.88% 5.37% 4.94% 4.68% 4.68% 4.68% 4.68% Senate bill interest rate 5.88% 6.73% 6.18% 5.66% 5.16% 4.81% 4.75% Increase NA 1.36% 1.24% 0.98% 0.48% 0.13% 0.07% Stochastic c analysis a s suggested: ed High likelihood of corridor effect through 2015 Near certainty about interest rate through

11 EFFECT ON CONTRIBUTION REQUIREMENTS Initially, a significant reduction in aggregate requirements relative to prior law (approximately 43% in 2012) Eventually, expected increase relative to prior law projections Expectation that, by 2014, contribution requirements would exceed recent historical highs 18 MEDIAN CONTRIBUTION REQUIREMENTS 19 10

12 SOLVENCY Estimated obligations measured with corporate spot curve Reduction in contribution requirements would temporarily reduce asset coverage relative to prior law Average $130 billion difference in the median level for the period 20 SOLVENCY 21 11

13 PREDICTABILITY Representative plan used to illustrate sponsor perspective Predictability of two results illustrated: Contribution requirements Reported funded status (FTAP) Predictability measured by range of stochastic results projected from 2012 Some near term improvement in predictability of contribution tib ti requirements Little improvement observed in the predictability of funded statuses 22 PREDICTABILITY 23 12

14 PREDICTABILITY 24 TRANSPARENCY Market value used as the standard for understanding the financial position of a plan Compared distribution of funded statuses on three bases: Market value Prior law Pension Funding Stabilization provisions For the portion of obligations considered 80% funded: Almost 30% difference between prior law and market Additional 30% difference under Stabilization provisions 25 13

15 TRANSPARENCY 26 IMPLICATIONS Some additional risk to PBGC and participants, to the extent sponsors default Significant volatility in required contributions would remain Changes in funded status would be affected by smoothing of valuation interest rates, not just plan/market performance (Final law included provisions to improve transparency.) Provisions would provide sponsors with a brief period of increased flexibility in how they allocate cash resources Significant effects of the provisions likely to be temporary Sponsors interested in leveling their contributions could contribute in excess of minimums during the short term 27 14

16 FEEDBACK WE RECEIVED In general, welcomed as an objective and unbiased resource otherwise unavailable to the public Some considered the report an attempt at lobbying against the legislation Particular interest among investment analysts Some SOA members conflicted to extent report perceived as slowing legislative progress 28 YOUR FEEDBACK? Thoughts on addressing specific legislative l proposals? Thoughts on addressing from principlesbased framework versus addressing in the context of the discussion (relief)? Thoughts ht on serving the public versus serving members? 29 15

17 PREVIEW OF THE NEXT REPORT A comparison of input and output smoothing techniques in the context of U.S. defined benefit funding regulation If smoothing, then how? Inputs : Factors going into a calculation Outputs : Results of a calculation Questions raised in MAP-21 deliberations 30 FRAMEWORK Input and output smoothing alternatives compared with regard to three principles: Solvency Predictability Transparency Report will focus on identifying and discussing issues Deterministic illustrations of single plan experience designed to highlight issues 31 16

18 ILLUSTRATIONS Three alternatives compared under each principle: Current law Increased input smoothing Extend interest rate and asset return smoothing from 24 to 60 months Remove 10% limit on smoothed asset value Increased output smoothing Amortization period from 7 to 10 years Graduated amortization schedule Two identical plans, except that: One is frozen no future accruals, and One is active new entrants and future accruals 32 SOLVENCY HOW SOON DO ASSETS RECOVER? Shock effects on funded status: Decline to 85% in interest rate scenario Decline to 72% in asset return scenario Alternatives to current law clearly lag due to additional smoothing No appreciable difference between input and output alternatives Output method appears slightly quicker in asset return scenario due to cap on smoothed asset value 33 17

19 SOLVENCY HOW SOON DO ASSETS RECOVER? 100% Funded Status Five Years After a Shock 95% 90% Funded status before shock Percent Funded* 85% 80% 75% Current Law 60mo Input Smoothing Modified Amortization 70% 65% 60% Frozen Plan Active Plan Frozen Plan Active Plan 1% Interest Rate Decline 20% Asset Decline *Funded status measured as market value of assets divided by estimated obligations discounted on corporate spot curve. 34 PREDICTABILITY Contribution Requirement* 100bp EIR 20% ROA (% of payroll) Frozen Plan Accruing Plan Frozen Plan Accruing Plan Before loss 0.0% 6.9% 0.0% 6.9% Year following loss Current Law 0.6% 8.8% 5.2% 13.4% 60mo Input Smoothing 0.1% 8.0% 1.1% 9.0% Modified Amortization 0.3% 8.0% 2.6% 10.2% Change Current Law 0.6% 1.9% 5.2% 6.5% 60mo Input Smoothing 0.1% 1.1% 1.1% 2.1% Modified Amortization 0.3% 1.1% 2.6% 3.3% *Adjusted to remove existing amortizations Input and output alternatives both significantly reduce volatility of contribution requirements Input alternative more effective for asset shock due to cap on smoothed asset value 35 18

20 PREDICTABILITY 18% Contribution Requirements Following a 1% Decline in Interest Rates 16% Percent of Payroll 14% 12% 10% Current Law 60mo Input Smoothing Modified Amortization 8% 6% The pattern of loss recognition is fairly predictable after a loss However, the pattern itself may be a source of volatility 36 TRANSPARENCY Difference between regulatory 100bp EIR 20% ROA and market funded ratios Frozen Plan Accruing Plan Frozen Plan Accruing Plan Before loss 0% 0% 0% 0% Year following loss Current Law 8% 9% 7% 7% 60mo Input Smoothing 10% 10% 21% 19% Modified Amortization 8% 9% 7% 7% Changing input smoothing affects the relationship between regulatory and market measures of funded status What this means for understanding the financial i position of the plan Alternative disclosures may help stakeholders What to do about correcting mechanisms in the law (e.g., At-Risk rules, Benefit Restrictions)? 37 19

21 EFFECT ON CORRECTING MECHANISMS Several correcting mechanisms become effective when regulatory ratio falls below 80% Number of years the Frozen Plan Accruing Plan funded ratio is below 80% Market Regulatory Market Regulatory Current Law mo Input Smoothing Modified Amortization Degree of input smoothing alters their effectiveness What is intent? If closer to the market ratio, safe sponsors (and their employees) may be penalized If farther from the market ratio, the value of the ratio becomes more questionable 38 FINDINGS AND IMPLICATIONS The rate of experience recognition had a greater effect on funded status recovery than the choice of input or output t methods The rate of recognition also had a greater effect on predictability than the choice of input or output methods Greater input smoothing increased the difference between market and regulatory measures of funded status, while output smoothing did not Changes to input smoothing may affect whether correcting mechanisms function as intended 39 20

22 FUTURE OF THE INITIATIVE The pilot period has ended SOA Board approved continuation of the initiative Development of Canadian model and research Assessment of opportunities in health practice area 40 21