Retirement and Investment Webinar Series
October 14, 2015
Aon Hewitt
Retirement and Investment
Year-End Retirement Planning—
Financial Issues and Opportunities
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Joan Boughton
Eric Keener
Dan McFall
Alan Parikh
Brian Walker
Aon Hewitt
Retirement and Investment
Agenda Slide
Section 1
Section 2
Section 3
Section 4
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Retirement and Investment
Spot Rate Approach to Measuring Benefit Cost
Case Study: AT&T
Retirement Age Trends
Longevity Trends and Other Assumptions
3
Spot Rate Approach to Measuring Benefit Cost
Aon Hewitt
Retirement and Investment
4
Alternative Approaches for Measuring Benefit Cost
Spot Rate Approach
Traditional Approach
(Used by AT&T, calling it “full yield curve” approach)
 Plan sponsors using a corporate bond
yield curve approach to measure their
benefit obligations disclose a single
equivalent discount rate that produces
the same obligations as the full yield
curve
 The same single weighted average
discount rate is used to calculate:
− Service Cost
− Interest Cost on the benefit
obligation
❰❱
 Alternative concept evolved at
Aon Hewitt over past several years,
emerging from our significant
de-risking experience
 Discount rate assumption is viewed
as the full yield curve rather than the
single equivalent rate, so each spot
rate along the yield curve is applied to
each corresponding benefit cash flow
 More granular interest cost
computation, grounded in accounting
literature’s requirement to “accrue
interest cost at rates equal to the
assumed discount rates”
 Service Cost more precisely
determined based on durationspecific spot rates applied to the
service cost cash flows
 No change to the benefit obligation
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Determining Interest Cost: Comparing Two Yield Curve Approaches
Traditional Approach
Aggregated Discount Rate of 4.33%
Spot Rate Approach2
PBO-Weighted Average
Interest Cost Rate of 3.62%
6.0%
$500
5.0%
$400
4.0%
$300
3.0%
$200
2.0%
$100
1.0%
$0
0.0%
2015
2020
2025
2030
Effect of Discounting
1
Yield Curve
1
2
2035
2040
2045
2050
PBO (PV of cash flow)
Single Equivalent Rate
Discount Spot Rate
PBO (in $millions)
$600
Observations on Spot
Rate Approach
 With upward sloping yield
curve, spot rate method
reduces current period
service and interest cost
 For a plan with PBO of
$1B, we typically see a
reduction of $6-9M in
interest cost
 Impact will vary based on
shape of the corporate
bond yield curve and
duration of the liability
 Differences between the
two approaches flow into
future accounting periods
reducing the gain
(increasing the loss)
Aon Hewitt yield curve, AA Above Median, December 31, 2014, used by XYZ Company Pension Plan.
Interest cost developed by applying each spot rate in the full yield curve to the present value of the cash flow corresponding to that rate.
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Retirement and Investment
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Plan Sponsor Considerations
SEC
Perspective
Accounting
Firm
Acceptance
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Retirement and Investment
In discussions with the Big Four auditing firms in September 2015, the SEC Staff
indicated that:
 They would not object to:
– Use of the spot rate approach
– Treating a change in approach as a change in estimate applied prospectively
 Companies should discuss appropriate, robust disclosures with their auditors
 Viewed as a one-way change since approach is presumably considered more
precise
 Companies may continue to use Traditional Approach since ASC 715 explicitly
allows for an aggregate average rate
PwC, KPMG, Deloitte, and EY bulletins are consistent with SEC perspective
 Expect any change at next formal measurement date
 Generally seem to expect consistent application to all defined benefit plans under
ASC 715
 Application to “bond matching model”: Companies should discuss with their
actuaries, auditors, and review intended changes with SEC staff
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Back Testing Analysis of Interest Cost Shows Volatility
ABC Retirement Plan ($1B PBO)
Estimated Reduction in Interest Cost
Relative to Traditional Approach
$ Millions
Curve
Flattened
2004–2006
10
9
8
7
6
5
4
3
2
1
0
Inverted Treasury
Curve 12/31/2006
Flat Corporate
Bond Curve
12/31/08
Reduction in Interest Cost
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Retirement and Investment
Fiscal Year
’04
’05
’06
’07
’08
’09
’10
’11
’12
’13
’14
’15
Equivalent
Discount Rate %
6.48
5.94
5.84
5.95
6.63
6.87
6.04
5.69
4.88
4.43
5.21
4.33
Spot Rate
Interest %
5.32
5.24
5.52
5.75
6.14
6.72
5.11
4.62
4.06
3.49
4.18
3.62
Reduction %
1.16
0.70
0.32
0.20
0.49
0.15
0.93
1.07
0.82
0.94
1.03
0.71
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Prevalence of Inverted Yield Curve
Frequent question when considering changes to the Spot Rate Interest Cost:
“How often does the yield curve invert?”
Treasury curve
Inverted ~19% of days since
1962 but only rarely since
the early 1980s
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Retirement and Investment
AA corporate bond curve
Inverted ~9% of days since 1973
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Spot Rate Interest Cost Sensitivity Analysis
Real issue for plan sponsors might not be inverted yield curves, but just changes in the
slope of the yield curve from measurement date to measurement date
 Changes in slope of yield curve can lead to additional volatility for future year-over-year expense
 Unpredictability
ABC Retirement Plan
ABC Retirement Plan
Spot Rate Interest Cost
Estimated Impact on FY16 to
FY17 Expense
 0.25% d-rate decrease 
$6M increase
 0.25% d-rate increase 
$5M decrease
Flatter
curve
creates
headwind
Yield Curve Slope
Estimated Impact on FY16 to FY17 Expense
PBO Discount Rate
Traditional Interest Cost
-0.25%
No
change
+0.25%
0.25%
flatter
+$13M
+$6M
$0
No
Change
+$6M
$0
-$5M
0.25%
steeper
$0
-$6M
-$12M
Rising rates and
flatter curve can be
offsetting factors
for companies that
amortize gain/loss
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Retirement and Investment
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Considerations in Adopting the Yield Curve Alternative
Potential Concerns

Potentially higher expense if corporate bond yield
curve becomes inverted

Increased year-over-year volatility as yield curve
changes
–

May be more difficult to budget pension expense,
creating more variance between budgets and
actual results
Lower settlement threshold (when Interest Cost and
Service Cost are lower)

Feasibility and impact for non-U.S. plans

Comparability with other companies

May impact compensation or reward elements tied to
certain earnings measures

Robust disclosures needed

Bond matching models—SEC staff did not provide
their views related to the “bond matching” approach
and application of spot rates to estimate service cost
and interest cost
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Retirement and Investment
Need to weigh
potential benefit of
more precise
measurements
against potential risk of
higher volatility
year-over-year
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Bond Matching Models
 SEC has not provided their views related to bond matching model
 Aon Hewitt believes that the bond matching approach and the full yield curve approach are fundamentally the
same since follow from same accounting guidance:
– Select individual spot discount rates with respect to year-by-year cash flows
– Spot discount rates are the yields from the bond portfolio that can settle the cash flows; accounting
literature mentions two cases
– Spot rates embedded in the PBO measurement should arguably be used in the computation of service
and interest cost in the disaggregated approach
Yield Curve
Bond Matching Model
Cash-matched
zero coupon
hypothetical
portfolio covering
each maturity date
PBO =
Fair value of
bond portfolio
that settles
cash flows
Not cash-matched
portfolio of
select bonds
which do not
cover each
maturity date
ASC 715-30-35-44
Full yield curve
represents
yields
on hypothetical
portfolio
Spot discount rates
= bond yields
Traditional
single rate
approach
(IRR of
bond
portfolio)
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Retirement and Investment
Spot discount rates
= bond yields
supplemented with
extrapolated spot rates
Spot rate
approach for
SC + IC
Practical expedient
traditionally used
Traditional
single rate
approach
(IRR of
bond
portfolio)
Incorporate
reinvestment
rates for
excess cash
in-flow
Spot rate
approach for
SC + IC
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Case Study: AT&T
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Retirement and Investment
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Case Study: AT&T Inc.
Background


Change



Recognition



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Retirement and Investment
Historically AT&T used the traditional approach to
determine Service Cost and Interest Cost for its
pension and OPEB plans
AT&T applies mark-to-market accounting such
that gains and losses are recognized in the
current period
First adopter of the spot rate approach beginning
in Q4 2014 following an interim remeasurement
No change in total expense due to mark-tomarket accounting
More precise measurement which improved the
allocation of expense to appropriate reporting
periods and entities
First adopter of
the spot rate
approach in Q4
2014
No change in
total expense
under mark-tomarket
Considered this a “change in accounting estimate
that is inseparable from a change in accounting
principle”
Recognized prospectively per ASC 250-10-45-18
EY issued a preferability letter which was
included with the10-K filing
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Retirement Age Trends
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Longevity and Retirement Age Assumptions
Longer life
expectancy
 Steady increases in life expectancy
 Advances in treatment of heart
disease and cancer, public health
improvements, smoking cessation
 Further improvements expected
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Retirement and Investment
Later retirement
ages
 Notable increase in retirement age
since 2000
 Social Security changes, decline in
defined benefit and postretirement
medical plans, low interest rates, and
healthier older workers
 Factors have not yet run their course
 Retirement ages expected to rise
further
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Actual Retirement Ages Have Increased
 Since 2005, the average age at which people retire has increased by about 1.4 years
 Sharp rise in people waiting until age 65-69 to retire (20.6% in 2005 to 33.5% in 2013)
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Average Age at Retirement
65.4
65
64
Aon Hewitt believes
that retirement ages
will continue to rise
across a wide range
of industries and
companies
64.0
Total
Women
Men
63
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: Author calculations using the Current Population Survey
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Key Drivers of Rising Retirement Ages
Social Security
 Full eligibility age
rising to 67 by 2027,
from 65 in 2002 and
66 today
 Delayed Retirement
Credit (DRC) fully
phased in since
2009
 Rising longevity
makes DRC
increasingly
valuable
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Retirement and Investment
Retirement
income
shortfalls
 Decline in DB and
retiree medical
coverage
 Low interest rates
 Rising longevity
Demographic
shifts
Structural
shifts
 Some industries
struggling to retain
workers
 Shift to later career
starts
 Takes longer to
achieve median
wage than in
previous decades
 Improved health
status
 Greater
automation of
routine and
physically
demanding tasks
 Specialized skills,
experience more
critical than ever
before
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Traditional Retirement “Triggers” are Disappearing
Defined Contribution Triggers Less Likely to Drive Behavior than DB
Value of Retirement Benefit
65 – Normal
Retirement
Value of Retirement Benefit as % Pay
62 – Unreduced
Defined Benefit
Defined Contribution
70.5 – Required
Minimum
Distributions
55 – Early
Retirement
59.5
55 and separation
from service
30
35
40
45
50
55
60
65
Age
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70
75
Why Retirement Age Assumptions Matter
Typical Impact
Greater Assumed Longevity
Rising Assumed Retirement Ages
Accounting
 Higher pension expense
 Higher balance sheet liability
 Lower pension expense
 Lower balance sheet liability
Cash
Contributions
 No impact until IRS revises
mortality tables (perhaps by
2017)
 Lower required contributions
PBGC Variable  No impact until PBGC adopts
updated mortality tables for
Rate
Variable Rate premium
Premiums
calculation
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Retirement and Investment
 Lower PBGC Variable Rate
premiums
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Will Retirement Ages Continue to Rise?
Questions for Plan Sponsors
 Are a greater
proportion of
employees working to
65 or even later?
 Has this trend
continued or even
accelerated in the past
few years?
Retirement
Experience
Study
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Workforce
Dynamics
Plan
Design
 Are you experiencing
labor shortages in key
functions as the boomer
retirement wave hits?
 Are you escalating
efforts to retain workers
with key skill sets?
 Do projections show a
rising number of
retirements over the
next five to ten years?
 Are your defined benefit
plans closed or frozen?
 Have you cut back your
postretirement medical
plans?
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Longevity Trends and Other Assumptions
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SOA Issues Updated Mortality Improvement Assumptions
 On October 8, 2015 the Society of Actuaries (SOA) released updated mortality improvement
assumptions for retirement plans (MP-2015)
 Reflects additional data that Social Security Administration has released since prior assumptions
(MP-2014) were developed
– Data shows lower mortality improvement in 2010 – 2011 than in previous years
– Results in lower projected future improvements in SOA model
 Key question: Does data indicate a new long-term trend? Or just random noise?
 SOA expects to:
– Release annual updates going forward
– Explore availability of more current information to decrease lag time
– Issue next update in mid-2016?
MP-2015 produces
1-2%
Typical reduction in plan
liability vs. MP-2014
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Actual Mortality Improvement Can Be Very Volatile from Year to Year
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Updated Mortality Improvement Assumptions –
Next Steps for Plan Sponsors
 Plan sponsors should consider reflecting new
data in 2015 year-end disclosures and 2016
expense
– Could use MP-2015 or an alternative
assumption
 If reflect new data this year, auditors may expect
annual updates going forward as new data is
released
– Could result in additional volatility
 Future updates could increase plan liabilities if
mortality improvement is greater than expected
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Retirement and Investment
Key Takeaways
 MP-2015 produces
lower liabilities
than MP-2014
 Consider reflecting
in 2015 disclosures
and 2016 expense
 Note potential for
added volatility
going forward
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Other Assumption Considerations
 Continued trend
toward lower rates
EROA
 For typical plan, up
~35 bp YTD @ 9/30
 Yield curves have
steepened
Discount
Rates
Medical
Trend
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 Consider explicit
assumptions for
active alpha
 AHIC develops
based on buyrated manager
performance
Active
Alpha
 In recent years, higher Rx and lower medical
 Can vary significantly based on plan provisions
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Questions and Answers
Email [email protected] with questions for our speakers.
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Speaker Biographies
Joan Boughton
Eric Keener
Dan McFall
Alan Parikh
Brian Walker
Aon Hewitt
Retirement and Investment
Joan is an actuary and Partner at the firm, co-leading Aon Hewitt’s national Retirement
Strategy and Design / IDEA team. She consults on HR and retirement strategy, design,
implementation, administration, communication, financing, and ongoing plan
management.
Eric is a Partner and Chief Actuary of Aon Hewitt's U.S. Retirement Practice. He leads
our National Actuarial Resource Team and is responsible for delivering training, thought
leadership, technical guidance, and day-to-day assistance to our consultants as they
serve our clients. He also consults with several large clients on a broad range of
retirement plan issues.
Dan is an actuary and Partner with Aon Hewitt. He is one of Aon Hewitt’s thought leaders
and consults with some of our largest retirement clients on retirement strategy, design,
financing, and ongoing plan management.
Alan is a member of Aon Hewitt’s National Actuarial Resource Team, helping Aon Hewitt
consultants deliver quality work and value-added consulting across the United States. He
is also a member of Pension Committee of the Actuarial Standards Board, a CFA
charterholder, and CAIA charterholder.
Brian is an actuary and Associate Partner in Aon Hewitt’s Retirement and Investment
practice. He advises clients on funding and accounting requirements for their retirement
programs, and provides strategic advice on retirement plan design, executive retirement
benefits, postretirement benefits, and plan administration.
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About Aon Hewitt
Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent,
retirement and health solutions. We advise, design and execute a wide range of solutions that enable
clients to cultivate talent to drive organizational and personal performance and growth, navigate
retirement risk while providing new levels of financial security, and redefine health solutions for greater
choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over
30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information,
please visit aonhewitt.com.
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