Annuities as Investments - Plan Funding

[Rob P]

We’ve gotten involved with a small db plan that allows active participants who have reached normal retirement to start receiving benefits. The plan also does not have a lump sum option.

Once an active participant reaches NRA and goes into pay-status, the trustees purchase an annuity (based on the participant’s AB and payment option) which is owned by the plan’s trust and monthly payments are made to the trust. On a monthly basis, the trust will then distribute a check to the participant. Note that because of post-NRA adjustments to the participant's AB (increase in salary/service), the annuity contracts do not match the actual payments distributed to the participants.

Question: Should the market value of that annuity contract be included in the funding calculations, or can the value of the contract (and liabilities associated that that portion of the AB) be eliminated from the funding calculations? Also, what about the AFTAP?

Any opinions or a regulation site would be appreciated.

[david rigby]

Yes, of course this should be included in funding. The Plan owns the asset and still has the liability.

However, be very careful about the "post-NRA adjustments". My guess is they should be zero (assuming the plan provisions are approximately what all other plans use).

[SoCalActuary]

From your description, you have made an irrevocable purchase of an annuity with no residual market value.

However, you have not discharged the plan's liability for benefits, because the participant does not have the exact same interests as the plan.

So I would value the market value of the benefits at the normal funding rates, and value the annuity contract as an offset to that benefit.

The valuation of the contract does have some flexibility here, because you can value the future payments at current market rates, at MAP-21 rates, at plan actuarial equivalence rates, or at maximum funding rates. So you have essentially purchased a financial instrument to minimize some of the longevity risk.

[Rob P]

It was my understanding that the annuity values should be included in the calculations; as such we requested a market value statement for each policy that the plan owns. One of the insurance carriers who issued a policy is telling the client that we don’t need the MV information (others did give us a MV calculation without a problem). The plan owns several policies.

SoCalActuary, in my research I did an BNA article that mentions if an insurance product does not have a surrender option and the participant’s right to receive the benefit is irrevocable, then the liability of that benefit does not need to be reflected in the FT and TNC calculations. However, I could not find anything in the actual regulations or any additional articles to clarify. In this case since the plan owns the policies I was not sure if this applied anyway.

So to conclude, the benefit liabilities should stay in the calculations and the value of the annuities should be included in the assets. However, the annuity values can be something reasonable which essentially offsets the benefit liabilities associated to that policy.

I appreciate the input; extremely helpful. Thanks!!

David – explaining the issues to the client regarding post NRA adjustments (or lack thereof in most cases) has been a problem too. Definitely another project.

[david rigby]

.. explaining the issues to the client regarding post NRA adjustments (or lack thereof in most cases) has been a problem too. Definitely another project.

This is likely a matter of understanding what the plan says. It's possible the plan uses a more generous provision than is required. But, it's not likely. Might need an independent review of the provision, from a pension actuary or an ERISA attorney.