Living benefit riders to life insurance policies: Pricing considerations and strategy
Adding benefit riders to policies provides meaningful coverage for those who need it, and carriers usually can do so at a relatively low cost.
In March, President Biden signed into law the American Rescue Plan Act of 2021 (ARPA), which included two major provisions for corporate single employer pension plans:
|2020 Plan Year||2021 Plan Year|
|Benefits payable within 5 years||3.64%||4.75%||3.32%||4.75%|
|Benefits payable in 5-19 years||5.21%||5.50%||4.79%||5.36%|
|Benefits payable in 20+ years||5.94%||6.27%||5.47%||6.11%|
Note that while we only show 2020 and 2021 above, ARPA will affect interest rates for all future years.
* The law is unclear whether electing 2021 as the effective year for this provision is allowed. Awaiting IRS guidance for clarification.
These two provisions are designed to lower the contribution requirements for plan sponsors to give them some relief in these difficult economic times. For more details, please see Milliman’s Client Action Bulletin: Single employer defined benefit pension plan relief enacted in the American Rescue Plan Act of 2021.
While we’re still waiting on Internal Revenue Service (IRS) guidance to clarify the details of how these provisions will work (especially regarding the optional retroactive effective dates), we have begun analyzing the impact ARPA may have on our clients. Following are four brief case studies of the impact of ARPA.
Prior to ARPA, Client A had a January 1, 2020, funding target liability of about $375 million, a funding target attainment percentage of 92%, and a minimum required contribution (MRC) of $10.5 million. If it chooses to retroactively implement the new ARPA interest rates to the 2020 plan year, that will lower its funding target liability by about 3% to $364 million.
Client A had several large amortization bases as of January 1, 2020. As a result, we looked at the impact of eliminating its existing amortization bases (i.e., “resetting” its bases) and adopting the 15-year amortization period. The combined impact of reducing its funding target by 3% and resetting and adopting the 15-year amortization period reduces its 2020 minimum required contribution from $10.5 million to $5.5 million.
Further, pension plan sponsors are required to make quarterly deposits. The amounts of these quarterly deposits are based on the plan’s prior year funding requirements until funding requirements for the plan’s current year have been determined. Prior to ARPA, Client A was required to make a $2.6 million deposit each quarter during 2021. Not only will ARPA reduce the 2020 plan year contribution requirement from $10.5 million to $5.5 million but it will also reduce each 2021 quarterly deposit from $2.6 million to $1.4 million.
It is worth noting that Client A has already funded more than $5.5 million for its 2020 plan year because it was on a $10.5 million contribution schedule. Client A will be able to apply the excess contributions toward its 2021 plan year funding requirements. The excess will cover its first two $1.4 million deposits, as well as a portion of its third deposit.
Lastly, we have been working aggressively with Client A to help it mitigate the cost of the plan’s Pension Benefit Guaranty Corporation (PBGC) premiums. Specifically, since the time Client A hired Milliman two years ago, we have helped it implement strategies to reduce the plan’s annual PBGC premium from $5.0 million to $2.7 million. ARPA will reduce the contributions that Client A is required to make in 2021. However, given that Client A had already budgeted a larger contribution schedule, one option we’re discussing with the client is maintaining, or possibly modestly accelerating, its previously planned contributions to reduce its PBGC premiums in 2021.
Due to the cash flow flexibility ARPA offers to Client A, we are recommending that it elects to make both the interest rate and shortfall amortization base changes of ARPA effective for the 2020 plan year.
Prior to ARPA, Client B had a January 1, 2020, funding target liability of about $200 million, a funding target attainment percentage of 130%, and no minimum required contribution. As of January 1, 2021, Client B has a funding target of about $220 million, a funding target attainment percentage of 135%, and no minimum required contribution. Additionally, Client B did not have any PBGC variable rate premiums for 2020 and will not have any PBGC variable rate premiums for 2021. Client B does a full remeasurement of its liabilities at year-end for its accounting disclosures and thus its IRS funding valuation as of January 1, 2021, was well underway when ARPA was signed into law. Therefore, we are recommending that Client B defer both the interest rate changes and implementation of the shortfall amortization change of ARPA until January 1, 2022.
Prior to ARPA, Client C had a January 1, 2020, funding target liability of about $96 million, a funding target attainment percentage of 95%, and a minimum required contribution of $1.8 million. If it chooses to retroactively implement the new ARPA interest rates to the 2020 plan year, then it will lower its funding target liability by about 3% to $92 million. This would lower its minimum required contribution for 2020 from $1.8 million to $1.3 million.
We looked at the impact of changing the amortization period to 15 years. However, implementing this change in 2020 is not beneficial for Client C. Due to great asset returns in the last few years, Client C has several negative amortization bases that are lowering the required contributions. Switching to the 15-year amortization period would mean wiping out these negative bases, so it would actually raise the 2020 minimum required contribution from $1.3 million to $1.4 million.
Therefore, we are recommending that Client C elect to make the interest rate changes of ARPA effective for the 2020 plan year but defer implementation of the shortfall amortization change. This will lower its required contribution for 2020 by almost a third, giving it the option to free up cash for other company priorities.
Client D is an off-calendar year plan, which will have fewer complications with respect to revising and reissuing prior work, as we have not yet issued its 2020 valuation or filed its 2019 Schedule SB.
Client D has limited ability to make contributions outside of well-established budgeted amounts. Since the Pension Protection Act (PPA) became effective in 2008, its funding policy included increased contributions to build and maintain a prefunding balance that would help smooth its potentially volatile required cash contributions. Over the years, as the various relief measures have been implemented and gradually phased out, its primary concerns revolved around the phase-outs and how they might impact future contribution requirements, particularly the lower segment rates. ARPA is yet another instance of such relief. Prior legislation was beginning to phase out starting in 2021, and forecasting of the phase-out was projected to nearly double the budgeted contributions as early as 2027, as the prefunding balance was spent down due to the increased contribution requirements. ARPA has dramatically changed that outlook.
In terms of its immediate decision, our analysis showed that early adoption of the amortization base changes in 2019 could be used to eliminate all prior bases, and reduce Client D's 2019 required contribution by 20% to help it add to, instead of spend down, the prefunding balance for the 2019 plan year. Similarly, adopting ARPA interest rate relief in 2020 improves its funding target attainment percentage from 98% to 101%, which in conjunction with previously eliminated bases would reduce its 2020 minimum required contribution by 25%, helping it make further additions to its prefunding balance.
We have projected the impact of ARPA over the next 10 years to show that, with all other assumptions unchanged, ARPA will lead to significantly reduced minimum required contributions and increased prefunding balances. Interest rate relief is the primary driver, particularly the 5% floor on the underlying segment rates. With this, the plan is projected to stay over 100% funded through 2029, allowing Client D's budgeted contributions to build more prefunding balance, which will last longer as ARPA relief begins to phase out (unless replaced with future legislation?).
As highlighted in these case studies, the impact of ARPA affects each plan differently. Some plans may find it more advantageous to apply both ARPA provisions as far back as possible, others may want to defer them both to 2022, and others may find that a mix and match approach is ideal. Therefore, Milliman is analyzing each of our clients’ plans to help them determine which options are best for their situations.
There are some common themes in these case studies. Implementing the ARPA interest rate change for the 2020 plan year lowers liabilities by about 3%. This savings is projected to increase in 2021 and beyond as the gap between the non-ARPA and the ARPA interest rates widens. As a result of this and the shortfall amortization change, most plans sponsors will see reductions in their minimum required contributions relative to the prior law.
Some plan sponsors may be eager to take advantage of ARPA’s lower contribution requirements to spend cash on other business needs. Others may wish to continue with their previously planned contributions to lower PBGC premiums or continue moving the plan toward termination (see Client Action Bulletin: Plan termination and de-risking strategies under the American Rescue Plan Act of 2021 for more discussion about this). However, all plan sponsors should appreciate the extra flexibility that ARPA gives them regarding the funding of their plans.