If you’ve read that corporate pension funds are extremely well-funded right now, that may be partially because they are using outdated mortality tables, which are used to estimate how much a defined benefit pension plan or annuity will need to pay out, because they are the best tools available. But new mortality tables are being developed by the Society of Actuaries (SOA), and when pension funds make the switch they will see their expected liabilities rise by as much as 7%.
Current tables use decades old assumptions
“The mortality assumptions currently used to value most retirement programs in North America were developed from data that are more than 20 years old,” says an SOA report explaining why the new tables are necessary. “The two most commonly used pension-related mortality tables are UP-94 and RP-2000, which were based on mortality experience with central years of 1987 and 1992, respectively.”
Most funds also used older mortality projection scales (which are used in conjunction with the tables), either the BB scale that was released in 2012 as a stop-gap measure before a new scale could be finalized, or the AA scale that uses information collected between 1977 and 1993 and no longer accurately represents mortality improvement rates.
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New tables will increase pension fund liabilities
While the new mortality table and projection scale haven’t been finalized, the SOA recommends that pension funds use both updated version when they become available. Depending on what they are current, the result of switching to the new standards will ‘vary quite substantially’, and funds that are still using the older AA projection will see the largest percentage change.
“These two papers represent a dramatic change in mortality assumptions that will result in significant financial consequences for US pension plan sponsors,” according to an Aon Hewitt report published in February, reports Leanna Orr for aiCIO. “Although many variables come into play, the increase in liabilities could be 7% or more for many plan sponsors.”
The mix of male and female employees, whether the work is white or blue collar, and average age all come into play so it’s hard to pin down a meaningful average increase in liabilities, but it seems clear that most pension funds will see their funding rates drop when they make the switch, which could happen this year. Corporate pension plans will look a little less sterling, and of course public pensions that are already under pressure will have even more ground to cover.