Cash Option Amendment

[LIBOR]

Just wondering what techniques DB practitioners are using to estimate the funding impact of introducing a cash option to a plan?

Needed estimates would be (1) cash only at retirement (2) cash at retirement & termination and (3) cash at term but only if it's below a certain amount , e.g. $15,000.

[david rigby]

Assuming that "cash option" means the addition of a lump sum form of benefit distribution, a simple technique of estimating any increased funding (and expensing) needs is to value the post-decrement liabilities using an interest rate that more closely follows the GATT rate.

[LIBOR]

Thanks pax ! that's what I had in mind also & then it would just be a matter of making an assumption regarding the number opting for cash.

Assuming 100% would provide an upper bound !

Thanks again, pax, for your time & the response !!

[Guest Keith N]

I agree with PAX and would add that 100% would be a good utilization assumption. You may also want to consider an added load to account for the difference in your funding mortality assumption (m/b sex distinct) versus lump sum (unisex).

I am glad that you at least recognize the issue. I have taken over many plans that pay lump sums and the prior actuary was not recognizing the lump sums in the funding. This causes lots of problems, especially when you tell the client that although his plan is fully funded, he can't terminate it because his assets are not sufficient to pay the lump sums.

[david rigby]

Keith is correct. However, I would not bother with a "load" for the unisex mortality. Instead, just use the appropriate mortality table in the calculation.

BTW, for most US plans, the applicable mortality table will be changing on 12/31/2002.

[LIBOR]

Keith - I think we have the option of explicitly funding for the lump sum option through assumption selection or funding for it prospectively after it is utilized via the gain/loss amortization.

For a client with demographics that indicate utilization of the option in the distant future, prospective handling might make more sense after a cash flow analysis.

The different mortality tables is a good refinement.

Pax, what does BTW stand for ????

And again, thanks again for the feedback !!!!!

[LIBOR]

Pax - I jus got it "By the Way" ; Rev.Ruling 2001-62 right ?

[david rigby]

Yes, Rev. Ruling 2001-62 is the correct one.

But a word of caution. I should have pointed out that the change in mortality table for the purpose of determining a minimum lump sum. The plan definition might be different.

[Guest Keith N]

To some extent I agree, but my experience is no matter how big the plan is, if you offer a lump sum - the participant will take it 99% of the time.

Since your funding assumptions are based on some sort of long-term investment experience, it generally has some percentage of equity in the mix. Lump sums will most likely always be based on some sort of fixed income index. It may not be the 30-year rate, but it will always be lower than your actuarial funding assumption. Therefor, you have created an assumption that will consistently produce losses.

You already have turnover and retirement rates in your funding assumptions. Why not attach a realistic benefit to them? Why would you purposefully underfund a liability due to a specific contingency?

I know we like to take our clients cash flow issues into consideration when appropriate, and it may be acceptable to let the lump sum losses flow through your standard gain/loss. Either way, I would make sure my client is well aware of his “shut down” funding ratio at all times.

[Mike Preston]

99%? Have you ever heard of a participant actually taking an annuity when a lump sum is offered? I haven't. OK, maybe one in over 10,000. But that is at least: 99%+, not merely 99%. ;-)

Strangely enough, with lower overall interest rate expectations, we might actually see a full 1% or even 2% elect annuities now. Maybe even more. It will be interesting to see.

[Guest Keith N]

We just terminated a 50 life plan that offered lump sums and one person took an annuity - that's 2%!

I agree, that was the first time in many years that someone took the annuity, but with this crazy market, I would expect to see a few more.

[david rigby]

I have a plan that offers lump sums to all retiring employees. Current data shows 53 people in pay status and 58 who have received lump sums anytime in the past.

Don't know for sure, but I suspect this is a direct result of the J&S requirements for spousal signoff.

[MGB]

In large plans, a very large percentage take annuities.

One of the driving issues in the annuity selection is subsidized early retirement. Rarely does a large plan include that subsidy in the lump sum. So, for early retirees (which is the majority of actual retirees), the annuity is worth more than the lump sum.

Also, not everyone feels confident they can manage the investment of a lump sum. Especially when they hear the horror stories of their neighbors being ripped off by unscrupulous investment advisors.

[LIBOR]

MGB has a good point & we're starting to diverge into the financial planning arena a little but it's true that we'll only be able to measure which option (annuity or lump sum) was better after we die !

True ???

[david rigby]

Just one more reason that every man, woman and child should hire their own actuary!

[ishi]

I actually had an employee of a client take an annuity of about $30 / month over the lump sum so that she could have her hair done each month. She was the only one to take the annuity out of about 400 during this plan termination.