De-Risking Likely to Be More Expensive This Year, Study Says

Pension de-risking—paying a pension benefit as a lump sum and in the process eliminating the related liability—is likely to be much more expensive in 2020, says a recent analysis.

October Three says that it expects that it may cost a plan sponsor much more this year than in 2019 to de-risk pension plan liabilities. It bases this conclusion on three factors: interest rates, Pension Benefit Guaranty Corporation (PBGC) premiums, and mortality assumptions.

Interest Rates

The present value of a participant’s pension benefit is paid as a lump sum when de-risking occurs. That present value is calculated using the first, second and third segment rates for a designated month; many sponsors, says October Three, set the lump sum rate at the start of the calendar year and base it on the rates in a prior year “lookback” month. A plurality of plans, they say, use November as that month. And the rates in November 2019, they observe, were lower than those of the same month one year before; those lower rates will therefore have an effect throughout 2020 for many plans.

PBGC Premiums

The 2020 PBGC flat-rate premium is $83, and October Three projects that the 2021 rate will be $85; they arrived at that figure by adjusting the 2020 rate for inflation. They argue that reducing the number of pension plan participants reduces the risk for the plan as well as the variable rate PBGC premiums that must be paid. Those premiums, they note, are capped; however, as plan funding improves a plan may “fund its way out” of the cap.

Mortality Assumptions

In 2019, October Three notes, the IRS updated applicable mortality tables for 2021 and after, and the analysts estimate that mortality improvements will reduce the cost of de-risking.

The Bottom Line

October Three anticipates that drops in lump sum valuation rates will be the most important factor affecting the cost of de-risking, and that they will make it “significantly more expensive” in 2020 than it was in 2019. And they add that they expect that the effect of changes in mortality rates will not be sufficient to neutralize that increased cost.