Lump Sum implications of WIDE treasury-to-Corporate spread

[Guest DBPension]

Today, the IRS came out with the March 2009 30-year treasury rate (3.64%) and the 3-segment Corporate bond rates (5.70%, 7.53%, & 7.85%) ... see www.irs.gov/pub/irs-drop/n-09-39.pdf

Converting the (payout year 2009 60%/40% weighted) resultant Minimum PV Traditional Segment Rates (of 4.46%, 5.20%, & 5.32%) into a SINGLE interest rate gives 5.04% or 140 basis points above the 30-year treasury rate. THIS is with only 2 of the 5 years of grade-in now in effect. If this treasury-to-corporate spread holds, when fully graded-in (in 2012) the lump sum interest rate wil be 350 basis points (5 x 70 basis points per year) higher than the earlier (30-year Treasury) basis. The impact for a retiree approx age 60 is a one third reduction in the lump sum that would have been generated in the absence of the change in basis. In the period surrounding the 2006 PPA's passage, ths spread (once FULLY graded-in) would have been only 125 basis points or about 25 BP per year (NOT he 70BP per year we are now seeing). Certainly, Congress never contemplated a lump sum reduction of this magnitude.

Has anyone been involved in responding to participant-generated questions/complaints? Certainly, they cannot be well versed in the details, but it seems questions should be coming asking "why is my lump sum decreasing while my annuity is rising". Of cousre half-truthes can be used to explain it away, such as "its must be because your life expectancy is dropping with each passing year".

I'll bet some knowledgable Plan Administrators are "dancing in the isles" with this outcome ........ which scares me what abuse they may look to extract from AFTAP timing opportunities.

[Andy the Actuary]

A very old lady wearing a new dress. This problem has been around since TRA86 when 417(e) became part of the code. First it was with PBGC, then 30 year treasuries, now with whatever. Whenever lump sum quotes have been given, they are always caveated that (a) they depend upon government rates and (b) a decrease/increase in interest rate creates an increase/decrease in lump sum.

In the old days when we wrote on professional bulletin boards with chalk, savvy employees understood this relationship in (b). It was reasonably common, especially where lump sum rates changed annually for employees to time their retirement to December or January depending upon the PBGC interest rates.

I doubt that Plan Administrators are sweating bullets. They will simply answer, "It is the law."

[david rigby]

IMHO, it matters not what the spread is. It matters only that lump sums are valued at market rates. You may have legitimate complaints that the IRS rates are not real market rates (for example, there are no real market rates for the long durations in the yield curve), but (it should be clear) that the old basis was not a real market rate.

[Effen]

The PPA structure just brings lump sums back to a more reasonable value. Prior rule (PBGC, 30-yr Treasury) both started out reasonable, but as market conditions changed they both started to produce redundant lump sums. Theoretically, the lump sum should represent the present value of the annuity based on market conditions. If there wasn't any advantage to the participant, or penalty to the sponsor, lump sums would be a non-issue. The change to the PPA structure is the latest attempt to produce a reasonable lump sum. Using the 30-yr rates or the PBGC rates participants could take a lump sum, and then turn around and purchase an annuity to provide a monthly benefit higher than the actual accrued benefit. That shouldn't be allowed to happen.

So, yes, knowledgeble participants may be upset, but shame on Congress for creating a system where employers were forced to overpay.

Now, if we could only get them to do something about the excise tax on reversions we might be able to actually help the retirement system...

[SoCalActuary]

Today, the IRS came out with the March 2009 30-year treasury rate (3.64%) and the 3-segment Corporate bond rates (5.70%, 7.53%, & 7.85%) ... see www.irs.gov/pub/irs-drop/n-09-39.pdf

Converting the (payout year 2009 60%/40% weighted) resultant Minimum PV Traditional Segment Rates (of 4.46%, 5.20%, & 5.32%) into a SINGLE interest rate gives 5.04% or 140 basis points above the 30-year treasury rate. THIS is with only 2 of the 5 years of grade-in now in effect. If this treasury-to-corporate spread holds, when fully graded-in (in 2012) the lump sum interest rate wil be 350 basis points (5 x 70 basis points per year) higher than the earlier (30-year Treasury) basis. The impact for a retiree approx age 60 is a one third reduction in the lump sum that would have been generated in the absence of the change in basis. In the period surrounding the 2006 PPA's passage, ths spread (once FULLY graded-in) would have been only 125 basis points or about 25 BP per year (NOT he 70BP per year we are now seeing). Certainly, Congress never contemplated a lump sum reduction of this magnitude.

Has anyone been involved in responding to participant-generated questions/complaints? Certainly, they cannot be well versed in the details, but it seems questions should be coming asking "why is my lump sum decreasing while my annuity is rising". Of cousre half-truthes can be used to explain it away, such as "its must be because your life expectancy is dropping with each passing year".

I'll bet some knowledgable Plan Administrators are "dancing in the isles" with this outcome ........ which scares me what abuse they may look to extract from AFTAP timing opportunities.

Pension plan sponsors never planned for lump sum payments at interest rates below 4% either. Don't forget that this capital market is terribly skewed toward safety of capital, so Treasuries are way over-priced for their expected returns.

Don't try to make me feel bad for the participants here. They are already getting a much better deal than anyone expected by having the forced transition rules in 417(e).