March 25, 2015
- Council Testifies on Swaps and Pension Plans
- Council Letter to Treasury, IRS Outlines Concerns with 2014 Mortality Table Updates
- ERISA Advisory Council Announces 2015 Discussion Topics
Council Testifies on Swaps and Pension Plans
In a March 24 hearing before the U.S. House of Representatives Agriculture Subcommittee on Commodity Exchanges, Energy and Credit, Lisa Cavallari, Director of Fixed Income Derivatives at Russell Investments, testified on behalf of the Councilon implementation issues that affect the use of derivatives (such as swap trades, or “swaps”) by defined benefit pension plans and could have very adverse effects on plans and on their ability to mitigate risk.
The hearing, Reauthorizing the CFTC: End-User Views, examined the reauthorization of the Commodity Futures Trading Commission (CFTC) and the challenges for those who use the derivatives markets (end-users) to hedge and manage risk. The Dodd-Frank Act (Dodd-Frank) added greater transparency to the marketplace. Also, the CFTC, which has jurisdiction over the types of swaps most important to pension plans, along with other agencies and prudential regulators, have worked hard to provide guidance.
Nevertheless, there are a number of challenges that are emerging with the transition from the rulemaking phase of Dodd-Frank to the implementation phase. These need to be addressed so that the derivatives marketplace continues to evolve in a way that ensures access and use by pension plans. The issues are multi-faceted and complicated by a number of factors including the range and technical nature of the products available and applicable rules, the global aspects of the marketplace and the number and types of end-users of the products.
In his opening statement, Subcommittee Chairman Austin Scott (R-GA) outlined the principles that would guide the subcommittee’s work: that “derivatives markets exist to meet the needs of hedgers, regulatory requirements should be both minimized and justified and regulations should provide clarity and certainty.” He noted the difficulties faced by users in complying with the regulations issued after Dodd-Frank was enacted and stated the need to clarify the congressional intent in Dodd-Frank, minimize regulatory burdens and preserve users’ ability to manage risk in derivatives markets.
Cavallari’s testimony emphasized that pension plans are high quality credit counterparties. She highlighted the importance of swaps trading to defined benefit pension plans as a way of mitigating risk. She explained the impact that changing interest rates can have on plan liability and how pension plans can cost-effectively mitigate risk by employing interest rate swaps. However, a number of factors are increasing costs associated with derivatives and creating barriers to pension plans’ use of derivatives. These costs are both implicit and explicit. Examples of the explicit costs are those that have grown out of the requirements around cleared swaps. Implicit costs include the costs associated with all of the new regulatory requirements, including new legal definitions, new requirements affecting agreements and documentation as well as compliance with new timelines and the communication challenges caused by the new rules.
“Pension plans and other end-users of derivatives benefit from cost efficient ways to obtain their exposure” in the derivatives marketplace, Cavallari said. “Some cost pressures associated with derivative use by pension plans are a direct result of some unintended consequences that are created when considering the implications of different global regulations.” Her testimony then noted several specific areas of concern for defined benefit pension plans that can affect pension plan trading by making them less desirable as clients in derivatives markets and further hindering their access to risk mitigation in derivatives markets. (The Council hosted a recent webinar on the impact of Basel capital requirements on pension plan trading; to receive a playback of the webinar, please contact Jason Hammersla.)
The subcommittee also heard from the following witnesses:
- Douglas Christie, president of Cargill Cotton, testifying on behalf of the Commodity Markets Council, noted that the CFTC’s implementation of swap regulations has “morphed” into proposing regulations that were not intended by Congress in Dodd-Frank. He noted that the complexity and regulatory uncertainty not only adds costs but also creates risk for participants.
- Lael Campbell, director of regulatory and government affairs at Constellation, testifying on behalf of the Edison Electric Institute, noted support for the Dodd-Frank Act’s goals to protect the financial system against risk and increase transparency, but suggested adjustments to ensure against inadvertent barriers to the ability to hedge.
- Mark Maurer, chief executive officer at INTL FCStone Markets, LLC, testified that the proposed margin and capital rules would cause firms like his to assume large financial burdens that will then be passed on to their customers and place both parties at a competitive disadvantage. He advocated that regulations continue to allow even small end-users to have access to hedge risk.
- Howard Peterson, Jr., owner and president of Peterson’s Oil Service, testifying on behalf of the New England Fuel Institute, testified from the perspective of an end-user of energy commodities. He voiced support for expanded protections for small hedgers and protecting against fraud and manipulation.
During the question-and-answer period, Cavallari emphasized the increasing implicit and explicit costs on defined benefit pension plans, as well as the importance of preserving the liquidity of the derivatives market to benefit the diversity of market participants.
For more information, contact Lynn Dudley, senior vice president, global retirement and compensation policy, at (202) 289-6700.
Council Letter to Treasury, IRS Outlines Concerns with 2014 Mortality Table Updates
In March 23 written comments to the U.S. Department of the Treasury and the Internal Revenue Service (IRS), the Council urged that in connection with the issuance of updated mortality assumptions for purposes of the Internal Revenue Code, the Internal Revenue Service address problems and inaccuracies in the methodology used by the Society of Actuaries (SOA) in calculating rates of mortality and the mortality projection scale issued by SOA in October 2014.
The SOA issued the final versions of the RP-2014 Mortality Table Report and the MP-2014 Mortality Improvement Scale, along with formal responses to comments on the earlier mortality table exposure draft and responses to comments on the mortality improvement scale exposure draftin October 2014 (see the October 27, 2014, Benefits Byte). These documents, based on a study of uninsured retirement plan mortality experience begun by the RPEC in late 2009, would establish a new basis for mortality assumptions for retirement programs in the United States. For pension-related purposes, the mortality projection scale presented in this report, denoted MP-2014, would replace both Scale AA, which was released in 1995, and the interim Scale BB, which was released in 2012.
For accounting purposes, auditors may currently take into account the assumptions published by the SOA. For purposes of pension funding, benefit restrictions, Pension Benefit Guaranty Corporation (PBGC) premiums and other related purposes, SOA’s assumptions have no direct effect, but are usually taken into account by the government in formulating updated mortality assumptions.
The March 23 Council letter outlines several key inaccuracies in the SOA’s methodology, including:
- The method used by the SOA to project the 2006 data to 2014 to produce the 2014 base tables. The method used by the SOA causes the RP-2014 tables to overstate the near-term rate of improvement for 2007 through 2009. Moreover, the assumptions on which RP-2014 is based conflicts with data collected more recently by independent sources, such as the Social Security Administration, the Center for Disease Control, and the Human Mortality Database, which demonstrates significantly lower rates of improvement than the rate assumed by the SOA for 2010 through 2012.
- The exclusion of lump sum recipients from the data used to determine lump sum valuations.The Council emphasized that the exclusion of this data would generate incorrect mortality rates and improvement scales, which could “create an uneven playing field, biasing employees in favor of electing lump sums and against electing annuities that provide guaranteed income for life.”
- The SOA’s assumptions about future improvements. SOA’s assumptions are based on recent volatility in mortality improvement, not long-term historical trends, thus introducing inappropriate and undesirable volatility into the valuation process.
- Small plans need simple mortality rules that are geared to their unique circumstances.
- The exclusion of other data from the SOA’s analysis. The SOA analysis inappropriately excluded a significant portion of data for several reasons in part because it differed materially from “expected” data or that a consolidated record for participants at the overall plan level could not be produced for the entire exposure period. The letter also notes that PBGC data was never collected during the original study (that data is now with SOA).
- Funding rules. The funding rules permitting the use of substitute mortality tables should be modified to reflect established actuarial credibility theory so that companies with different mortality experience can base assumptions on their experience, rather than a table that does not fit their participant population.
The letter notes the possible effects that the overstatement of life expectancy in the SOA tables could have if reflected in regulations issued by Treasury and the IRS, including the significant overvaluation of defined benefit pension plan liabilities, lump sums and other optional forms of payments, triggering plan sponsors to be forced to either overfund their plans or potentially to cut or freeze benefits. It emphasizes the additional pressures that would be placed on the defined pension plan system and would further challenge the health and existence of the private sector pension system.
The Council letter also requested that the new assumptions issued by the Treasury Department and IRS “not be effective until plan years beginning after December 31, 2016 and that there be at least a 12-month period between finalization of the new assumptions and the effective date of those assumptions.”
For more information, contact Lynn Dudley, senior vice president, global retirement and compensation policy, at (202) 289-6700.
ERISA Advisory Council Announces 2015 Discussion Topics
On March 20, the ERISA Advisory Council (EAC), a group of benefits experts established by Congress and appointed by the U.S. Department of Labor (DOL) to identify emerging benefits issues and advise the Secretary of Labor on health and retirement policy, has released its working group topics for 2015: pension fund de-risking and lifetime plan participation (relating to plan distributions and rollovers).
As we reported in the December 17, 2014, Benefits Byte, the chair and vice chair, respectively, of the EAC for the 2015 term will be Paul M. Secunda, professor of law and director, Labor and Employment Law Program at Marquette University Law School, and Mark E. Schmidtke, shareholder of Ogletree, Deakins, Nash, Smoak & Stewart (a Council member firm).
Several EAC members are associated with organizations that are also members of the American Benefits Council. We are pleased that both the DOL and the EAC have the benefit of advice on public policy development from these individuals and organizations. They are:
- Josh Cohen, head of institutional defined contribution, Russell Investment Group, representing investment counseling.
- Christina R. Cutlip, managing director and head of plan sponsor services, TIAA-CREF, representing employers.
- Kevin T. Hanney, director of pension investments for United Technologies Corporation, representing employers.
- Jennifer Kamp Tretheway, recently retired managing director of investment program solutions with Northern Trust Asset Management, representing corporate trust.
- Deborah A. Tully, senior director of compensation and benefits finance and accounting analysis at Raytheon Co., representing employers.
- Rennie Worsfold, vice president at Financial Engines, Inc., representing investment management.
During the first portion of the meeting, Assistant Secretary Phyllis Borzi of the DOL’s Employee Benefits Security Administration (EBSA) spoke to the group about some of the DOL’s current initiatives, including the upcoming fiduciary rule currently under review at the Office of Management and Budget (OMB) (see the February 23 Benefits Byte).
The EAC also decided on the aforementioned two topics at the meeting, rather than their customary three, although they agreed to focus on privacy and security issues during the morning session of the third day of their subsequent meetings. They agreed not to appoint a subgroup for the third subject (so there will not be a separate report) but anticipate laying the groundwork for a future EAC to address the privacy/security issue. The EAC has previously addressed both of these selected topics, with pension fund de-risking in 2013 and lifetime plan participation in 2014, and stated that it plans to focus on notices and disclosure, providing administrative assistance to the DOL. The Council testified before the EAC on de-risking in June 2013 (see the June 7, 2013, Benefits Byte). Final reports from prior years are available on the EAC website.
The EAC announced that its next meeting will take place May 27-29. For more information, particularly if you are interested in testifying on the Council’s behalf, contact Jan Jacobson, senior counsel, retirement policy, at (202) 289-6700.