2017 Fiscal Year-End Accounting Considerations
Many pension plan sponsors are in the process of figuring out what assumptions they will be using to value liabilities for their 2017 fiscal year-end disclosures. This article looks at what has changed this year and what that means for pension plan liabilities.
Presentation of Net Periodic Pension Cost
The biggest news this year came from FASB in the form of guidance for disclosing a pension plan’s net periodic pension cost (NPPC), also known as pension expense. This guidance will impact public companies disclosures after December 31, 2017 (i.e. starting in 2018). Implementation for non-public companies comes one year later, though early adoption is allowed. This guidance also applies to not-for-profit organizations. The FASB guidance was published in ASU 2017-07.
While the new guidance doesn’t change the calculation of the NPPC, how it’s presented on income statements will change. Going forward, only the service cost component of the NPPC will be reported as an operating expense. All other components of NPPC will be reported separately outside of operations.
Companies that have a significant focus on operating income/expense may see a significant impact from this change:
- Amortizations of net losses or prior service costs from plan design changes that have traditionally had a drag on operating income will no longer be a burden.
- Companies that have maintained aggressive investment strategies to justify a higher expected return on asset assumption may want to consider a different (less risky) strategy going forward.
- Companies that have avoided risk transfer strategies such as lump sum cashout windows or annuity purchases due to the impact from settlement accounting may find these strategies more attractive under the new guidance.
New mortality tables
Two new mortality updates await plan sponsors for December 31, 2017 disclosures. First, as anticipated, a new mortality improvement projection scale was released by the Society of Actuaries (SOA) in the fall. This scale is known as MP-2017. Similar to the past few mortality improvement scale releases, this new projection scale will lower liabilities around 1% for most plans.
The second mortality update comes from the IRS and has been anticipated for years. Many plan sponsors adopted the SOA’s newest tables for accounting purposes when they were released in 2014 (the RP-2014 mortality tables). The IRS finally released new regulations incorporating these tables into actuarial valuations beginning in 2018. Incorporating these tables in 2018 will increase lump sums, minimum funding liabilities, and PBGC liabilities.
By incorporating the new mortality tables into lump sum calculations, sponsors will generally pay 4%-5% more to a participant that elects to receive a lump sum than under the 2017 mortality tables. This should not impact plans that do not pay lump sums, and will have minimal (or zero) impact on plans that only pay lump sums up to a small limit (e.g. $5,000, $10,000). It also is not likely to impact plans that use a different (non-417(e)) basis for calculating lump sums including cash balance plans that pay the account balance as a lump sum.
For plans that do pay lump sums and value them for accounting purposes, there will be an increase in liabilities. How much of an increase will depend on other valuation assumptions such as the percentage of participants that elect a lump sum.
In addition to the new lump sum mortality, the IRS also updated the mortality basis for minimum funding requirements. This change should not have a direct impact on financial accounting results. However, some plan sponsors have continued to use the minimum funding mortality for accounting purposes, either as a non-material simplification, or because the underlying plan mortality is expected to resemble the “old” mortality tables used by the IRS through 2017.
Sponsors who have used the IRS minimum funding mortality will have a decision to make going forward as to whether to continue this practice. The fact that the IRS minimum funding mortality assumption is now much more in line with the most recent SOA mortality tables does open up an alternative for more plans to use this funding mortality table as the basis for accounting. Most plans however, have changed to, and have become comfortable with, the fully generational table which the IRS minimum funding mortality table attempts to mimic.
Finally PBGC liabilities will also most likely increase for most plan sponsors increasing 2018 PBGC premiums and pushing more plans to the variable rate premium cap. This may be significant if plans pay PBGC premiums from the trust and reflect those estimated amounts in the calculation of the NPPC.
Discount rates have dipped
Discount rates have come down since the beginning of the year. As of January 1st the Citi Pension Discount Rate Index was at 4.14% and as of November 30th it had fallen to 3.78% – a decrease of approximately 35 basis points. What is interesting to note is how steady rates have been since the end of August.
With discount rates dropping, pension liabilities will be increasing. For most plans liabilities will increase anywhere from 3% – 7%.
What plan sponsors should do
Plan sponsors will need to take note of these changes as they prepare for year-end financial reporting. A thorough evaluation of the impact of mortality assumptions is warranted for plans that pay lump sums or that have historically used the IRS mortality tables for accounting purposes. Sponsors will also want to take note of the potential impact the reclassification of the NPPC components have on their income statements. That reclassification could lead to discussions on investment strategy or other risk transfer strategies that they have previously avoided.
Director and Consulting Actuary
Bio: Click Here
Dan Atkinson is a Director in P-Solve’s Boston office.
Dan consults on all aspects of financial risk management for defined benefit plans as well as retiree medical plans and defined contribution plans. He has led numerous clients through pension risk transfers as well as other complex, strategic pension projects.
Dan also serves as P-Solve’s Chief Technical Actuary. He began his actuarial consulting career with Fidelity Investments. He also worked at Mercer prior to joining P-Solve in 2010.
He is a Fellow of the Society of Actuaries, an Enrolled Actuary, and a Member of the American Academy of Actuaries. Dan graduated from Worcester Polytechnic Institute with a BS in Actuarial Mathematics.
Director and Consulting Actuary
Bio: Click Here
Michael Clark is a Director and Consulting Actuary in P-Solve’s Denver office.
In his role he consults on all aspects of financial risk management for defined benefit plans as well as retiree medical plans and defined contribution plans. He also has led numerous clients through pension risk transfers as well as other complex, strategic pension projects. Michael leads P-Solve’s business in the West. Prior to joining P-Solve in 2013, Michael worked for Mercer as well as October Three.
Michael is a frequent speaker at industry and professional association conferences on the topics of pension risk management and pension plan administration and has had several articles published in major trade magazines. He currently serves on the Board of Directors for the Conference of Consulting Actuaries as well as the Western Pension & Benefits Council – Denver Chapter.
He is a Fellow of the Society of Actuaries, an Enrolled Actuary, a Fellow of the Conference of Consulting Actuaries, and a Member of the American Academy of Actuaries. Michael graduated magna cum laude from Brigham Young University with a BS in Statistics.
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