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Lump Sum & Optional Payment Forms

pension modes

In a projection, this topic allows you to specify low, medium and high benchmark yields for 30-year government bonds (e.g., U. S. Treasury rates, the yield on long term Government of Canada bonds). Additionally, for lump sum factors, optional payment forms and, in Canadian mode, excess contributions, the associated interest rates, mortality rate tables and conversion tables in all benchmark yield environments are specified. With this information, ProVal can use interpolation routines to determine appropriate lump sum and payment form conversion values for actual benefit payments in any benchmark yield environment specified for a deterministic or stochastic forecast.

First you specify the Lump Sum Benchmark Yield reference points, such as 3%, 6% and 9%, for the Low, Medium and High interpolation anchor points, respectively. Note that these specifications serve both as “labels” and as interpolation assumption points. They are labels in that the actual interest rate for computing lump sum factor values for experience lump sum amounts will be determined based on your specified assumptions for each lump sum factor component and optional payment form (see the discussion in the following paragraphs), so you may specify, for example, a 3% benchmark yield environment (i.e., the yield on the 30-year bond is 3%) but also specify a lump sum factor interest rate of 5% (i.e., lump sum values will be based on a 5% interest rate) in this environment. Thus, in a projection, you may reflect directly, for example, election of an optional lump sum form of payment where the lump sum payout, as stated in the plan provisions, is calculated using GATT mortality and, for the interest rate, the greater of the GATT rate (a yield on 30-year U.S. Treasury bonds, as defined under RPA ‘94) and the actuarial equivalence rate of 5%. The benchmark yield reference points are interpolation anchor points in that if you, in our example, specify that the 3% low benchmark yield environment has a 5% lump sum factor interest rate and the 6% medium benchmark yield environment has a 6% lump sum factor interest rate, ProVal will interpolate the lump sum interest rate under a 4.5% benchmark yield environment to be approximately 5.5%, or the low benchmark yield lump sum factor interest rate plus one half of the difference from the low to the medium environment lump sum factor interest rate.

ProVal will perform projections for all three benchmark yield environments, and use interpolation routines to obtain the effects of the benchmark yield at points within or even beyond these three values. Note that the medium yield will be used as the baseline to be held constant when sensitivities to variations in other Core Projection variables are being determined.

There are two sections remaining in the dialog box:

You further define the experience assumptions for these factors in the dialog box accessed when you click the name of the lump sum or conversion factor. For lump sum factors, the interest and mortality bases must be specified. For optional form conversion factors, either the interest and mortality bases must be specified or a Benefit Component Table must be selected.

If you wish, you may select a Plan Filter (in German mode, a Promise Filter), from the dropdown list, to reduce the list of possible choices to those Benefit Definitions associated with a particular Plan Definition (or in German mode a particular Benefit Promise). Please see Filters for details.

In Canadian mode, there is a button for Excess contributions.  These assumptions are used to calculate the experience benefit payments associated with excess contributions, if any, and the assumptions are specified the same way as for lump sums and optional payment forms. See the technical reference article Canadian excess contributions for more details.

The rest of this article discusses the parameters for interest rates and mortality tables, which apply to both lump sum factors and optional payment form conversion factors, and the optional form parameters for selecting a tabular conversion basis. For optional payment forms, selecting the Convert from normal payment form using Interest and Mortality option indicates specification of an interest and mortality conversion basis for an optional payment form, and thus instructs ProVal to calculate two lump sum factors, with different underlying payment forms: one is the normal payment form and the other is the optional payment form. The conversion factor is then calculated as the normal payment form lump sum factor divided by the optional payment form lump sum factor. This conversion factor is then multiplied by the normal payment form value to determine the value of the optional payment form. The discussion below uses the terminology “lump sum” but applies to calculating both the value of a lump sum factor Benefit Formula Component and the value of the two lump sum factors that comprise the conversion factor for an optional payment form.

You are asked to specify, for each lump sum benchmark yield environment, the associated Interest rate(s) for computing the lump sum amount (i.e., the present value as of the decrement date of the lump sum factor) or the conversion factor to be used for experience, or actual, benefit payments when an active member decrements. There are options to specify a Constant, or static, interest rate or an interest rate that is Variable by duration from decrement. Enter interest rate(s) as a number between 0 and 0.25, inclusive (not as a percentage). For variable rates, the duration may range from 1 to 99 years, inclusive.

If you select a Constant interest rate, the Pre-commencement rate is used to discount from the commencement date to the decrement date and the Post-commencement rate is used to discount payments from the payment date back to the commencement date. In many cases, if a Constant lump sum factor interest rate is specified, it will be the same as the benchmark yield or, at least, bear a direct mathematical relationship to the lump sum benchmark yield; however, it may be appropriate to have the interest rate differ from the benchmark yield, as when minimum or maximum interest rates constrain the associated lump sum experience interest rates.

The Variable by duration from decrement option was designed for Canadian users to reflect, in lump sum values paid over a forecast period, the regulatory solvency liability interest rate basis, under which commuted values (aka transfer values) are based on lump sum interest rates that vary over the post-decrement period. Selecting interest rates that are Variable by duration from decrement will make available a grid in which to enter two or more sets of rates, for the low, medium and high (experience) lump sum benchmark yield environments. Complete a row for each interest rate set. For example, if the interest rate is 4.5% / 6.5% / 8.5% in the low / medium / high lump sum benchmark yield environments for the first 10 years after the decrement date and is 1% lower in all environments thereafter, then enter:

From Up To Low Medium High  
-- 10 0.045 0.065 0.085  
10 -- 0.035 0.055 0.075  

ProVal fills in the Up To column automatically, and the last rate will be used for the last year entered and all years thereafter up to the date of each payment. Note that the From box in the first row cannot be completed. Our example involved only two interest rate sets: if you have several interest rate sets for the period after decrement, you may need to press the ENTER key, to create a new row, when you get to the bottom of the spreadsheet.

The Input is parameter tells ProVal whether to interpret any variable interest rates entered as forward rates or spot rates. If these are forward rates, then the rate specified at a particular duration from the decrement date (e.g., duration 2-3, indicating the time interval from 2 to 3 years after decrement) is used for all discounting during the specified time period, for all payments made during or after that period. The variable interest option with forward rates is coded, typically, with two durations – up to 10, 10 or more – for determining commuted values for solvency liability calculations for Canadian registered pension plans. If the rates are spot rates, then the rate specified at a particular duration from the decrement date (e.g., duration 0-5, indicating the time interval from decrement to 5 years after decrement) is used to discount the payment at that duration for the entire period from the decrement date until payment.

In our example, for a decrement occurring at 1/1/2007, in the medium lump sum benchmark yield environment, the (forward) interest rate used to discount annuity payments back to 1/1/2007 will be 6.5% until 1/1/2017, and 6% from 1/1/2017 on. Note that ProVal associates interest rates with plan years without regard to the valuation date, which treatment may differ from that of the same grid when entered for lump sum factor interest rates of Valuation Assumptions (depending on your selection for valuation assumption lump sum interest rates), because, in Valuation Assumptions, lump sum interest rates may vary by duration from either the valuation date or the decrement date. Hence, if the same grid is used in Valuation Assumptions and Projection Assumptions, experience, or actual, benefit payments may differ (depending on your coding inputs) from assumed, or expected, benefit payments, because the interest rate assumed to apply, in the calculation of valuation liabilities, for a particular plan year after the decrement has occurred might not be the same as the interest rate used for that plan year to compute a lump sum present value in the formula for the amount of benefit paid upon actual decrement. As a result, when used in a forecast, this experience assumption (that the interest rate varies by duration since decrement) can never have a built-in gain or loss (as the valuation assumption can), due to experience other than expected. (See the example of built-in gain or loss discussed under the Lump Sum & Optional Payment Forms topic of Valuation Assumptions.)

For all underlying payment forms except a certain only annuity, you are also asked to specify the Mortality rates assumed, for all interpolation anchor points, for computing the lump sum amount (i.e., the present value as of the decrement date of the lump sum factor) to be used for experience, or actual, benefit payments when an active member decrements. At first glance, it may seem surprising to have to specify the experience mortality, but the proliferation of alternative valuation assumptions for lump sum mortality requires an unambiguous mortality basis for the actual lump sum payout. Select from the library of mortality rate reference tables unhidden in the current Project (or previously defined for a Core Projection referencing either this Projection Assumptions set or a set from which it was copied by “saving as new”). Click the buttons on the right to create new mortality tables or edit existing ones.

If the payment form underlying the lump sum factor component is a joint and survivor type, or if either the normal payment form or an optional payment form for a conversion factor is a joint and survivor annuity, then there are separate parameters for Primary Annuitant and Contingent Annuitant mortality, with the same reference table choices available as indicated in the preceding paragraph.

In Canadian mode, you may select the option to <use inactive mortality assumptions> for the lump sum mortality.  If you select this option for the primary annuitant, the mortality defined for vested terminated under the decrements topic will be used.  If you select <use valuation assumptions> for the contingent annuitant, the mortality defined for survivors & beneficiaries will be used.  The <use valuation assumptions> option is only supported when the corresponding mortality is either a single rate table or only varies by coded field.

For details about coding the parameters for experience mortality rates in Projection Assumptions, refer to the discussion of the corresponding parameters of the Lump Sum & Optional Payment Forms topic of Valuation Assumptions. There is one exception, when the underlying payment form of the lump sum factor is a joint and survivor annuity: ProVal applies the experience marital assumptions specified by the Fraction of population that is married parameter and, except in the Canadian registered mode, the Fraction of married population electing J&S option parameter of the Other Parameters topic, rather than the valuation marital assumptions. (The valuation assumption for the age difference between husband and wife is, however, used as the experience assumption to determine the beneficiary’s age when the payment form underlying the lump sum factor involves a beneficiary as an annuitant.)

For optional payment forms, selecting the Convert from normal payment form using Benefit Component Table option indicates specification of a tabular conversion basis for an optional payment form, in lieu of (directly) calculating the conversion factors from interest and mortality bases. If this option is selected, choose (from the list of tables unhidden in the current Project) a Benefit Component Table that contains the desired conversion factors. The conversion factor value will be multiplied by the normal payment form value to determine the value of the optional payment form. To modify or create a Benefit Component Table, click the button.  Specify if the table values should be determined using Table look ups based on age at commencement or decrement.