People are living longer than at any other time in history. But what does that mean for defined benefit (DB) plan sponsors? Are there ways to help bolster the financial wellness of employees who might spend decades in retirement? And are sponsors prepared for the impact of longevity: its effect on their plan’s financial wellness? PLANSPONSOR discussed these questions with Russ Proctor and Marty Menin, both Directors of Institutional Sales at Pacific Life Insurance Company, to determine what plan sponsors should know about the impact of longevity.
PS: How long are people living today?
Proctor: When the subject is retirement planning, the real question is how long do people think they’re going to live? I hear
people approaching retirement who say they expect to live to age 76 because they remember hearing that’s the age of life
expectancy. However, that number is a little out of date and—more importantly—that’s from birth. Once you reach age 65, the
Society of Actuaries’ mortality tables show that males are typically living to age 86 and females to age 89.
Menin: Especially for married couples; there’s a 50/50 chance that one spouse will live to age 94, and a 20% chance one of
them will live to 100. Thirty to 35 years of retirement planning is a long time to plan for and to be certain that your money will last.
PS: Does longevity differ by demographics?
Menin: There are different ways to look at demographics, aside from the most obvious male versus female. The Society of
Actuaries’ (SOA) mortality tables have begun to break out things like blue collar versus white collar. Where individuals live, their education, and their income are also factors that affect longevity. From a DB plan sponsor perspective, they may have different populations covered by the pension plan—such as manufacturing and research divisions in which workers have different educational or income backgrounds—and they need to consider those to determine what the true longevity risk is for their pension plan.
Proctor: From the plan sponsor’s point of view, the difference between white collar and blue collar employees affects their
pension plan and how long benefit payments will be made. If you have a highly-educated, highly-paid white collar workforce, your risk may be much higher in terms of having to pay those benefits for a longer period of time and that will affect the plan’s financial wellness going forward.
PS: How does this impact qualified pension plans?
Proctor: With the qualified defined benefit plan, employees have guaranteed payments for life. There is really no longevity risk for the employee. It’s all on the employer. When you think of people living to age 86, 89 or even 100, the plan cost can increase significantly. It’s all the more reason to transfer that risk to an insurance company, that’s one of the reasons the buy-out strategy is so popular right now.
Menin: Most plan sponsors recently updated the mortality table they use to calculate the GAAP accounting pension liability. This increased the projected benefit obligations (pension liability) from 5% to 7%. Also, if these mortality rates continue to improve faster than projected, plan sponsors would need to update their liabilities again (Note: the SOA just updated their tables which reduced life expectancy by about 5 months).
Life Expectancy of Couples age 65 in 2014
Source: Society of Actuaries. "RP2014 and MP 2014," October 2014
PS: What’s the impact on nonqualified defined benefit plans?
Menin: These plans are typically offered to the highly compensated senior executives in a company. The interesting thing is that many plan sponsors use the same mortality assumptions for their non-qualified plan liabilities that they use and apply to their qualified plans. Thus, the non-qualified plan liability could end up being higher than expected.
PS: How does this impact individual retirement planning?
Proctor: When a plan sponsor terminates their pension plan, leaving only a defined contribution plan, the longevity and investment risk that was once in the defined benefit plan is now shifted to the employees. The employees are then responsible for managing those assets for their lifetime and if the market performs below their expectations, the employees are the ones that suffer. Maybe they invest too conservatively, or the market crashes right before retirement, it can cause a pretty severe hardship for the employees. In contrast, the plan sponsor benefits from the law of large numbers. They’re spreading these risks over a longer period of time, over several generations of employees in fact, whereas individual employees are subject to the investment performance of the assets they've accumulated.
Menin: Guaranteed lifetime income solutions have now become the next step in retirement plan offerings, and everybody is trying to figure out how to do it. It is difficult to protect oneself from longevity risk because you can build up a large account balance in a 401(k) plan, manage that money for 30 to 35 years and still have to think about watching the market and making sure you’re properly allocated for that extended period of time. Slowly but surely, plan sponsors will start getting serious about adding some kind of lifetime income solution to their 401(k) plans.
PS: What solutions are available to address these issues?
Proctor: Once plan sponsors complete a DB buy-out, they ask: “What do I do next?” One strategy is adding a group annuity option to the 401(k) plan, such as a Pacific Lifetime Income® annuity. When employees retire, an annuity option gives them the opportunity to purchase a guaranteed lifetime annuity with a portion of their 401(k) assets. This provides additional guaranteed monthly income to supplement Social Security benefits.
By offering an annuity option, the plan sponsor also provides a great educational opportunity because some employees just don’t understand what an annuity can provide in terms of guaranteed lifetime income. Employees often think, “If I die too soon, I’ll lose my money.” But by offering a Pacific Lifetime Income® annuity, employees can learn about multiple forms of annuities. They can discover that with a joint life option, money isn’t “lost,” it’s paid to their spouse. Or if both spouses pass away earlier than expected, a 20-Year certain payout ensures their beneficiaries receive the money.
Menin: At Pacific Life, we provide an interactive website that lets employers or advisers run different scenarios for their participants. Providing these different scenarios to participants helps them understand and evaluate the lifetime income options available to them.
Proctor: We hear many plan sponsors say they’re looking for more holistic ways to help employees with financial wellness. This means plan sponsors are thinking about whether employees understand their healthcare options, Social Security benefits, or investing basics. Educating employees about annuities can be an important part of that. After all, annuities are still one of the best ways to deal with longevity risk, which is an absolutely crucial factor in financial wellness for both companies and their employees.
The author of this article is not an employee or affiliated with Pacific Life. Pacific Life is not affiliated with PLANSPONSOR, PLANADVISER or Ernst & Young. This article was reprinted with the permission of PLANSPONSOR. Copyright© 2016 by PLANSPONSOR.
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