The noble mission of the Pension Benefit Guaranty Corporation (PBGC) is to pay benefits to the orphaned retirees of failed defined benefit (DB) plans (with some limitations). To date, they have taken responsibility for about 4,500 single employer DB plans, covering the shortfalls between benefits promised and assets collected.
For decades, this process has operated relatively quietly. Premium costs were accepted by plan sponsors as a minor, reasonable expense to insure defined benefit pensioners from unforeseen business catastrophes. Today, however, the situation is anything but quiet. The PBGC stated deficit as of September 30, 2013 is $27.4 billion (for the single-employer insurance program). Premiums are skyrocketing, and plan sponsor discontent with them is reaching a crescendo.
Picking up the tab
Awash in red ink with no other revenue source, premium increases were inevitable. Under current law this requires an act of Congress, which despite its supposed gridlock has found time to pass two hefty premium hikes in the past two years. (The last one wrapped into the December 2013 budget agreement as an early Christmas gift.) Thanks to this explosion of bipartisan cooperation, PBGC premium rates for 2016 can potentially be three times higher than 2012 rates. (Up to $64 per person plus nearly 3% of unfunded liability.) For a typically funded pension plan, this could reach 30 to 50 basis points of the total pension fund, a level that starts to raise eyebrows in an increasingly expense-conscious retirement world.
Not surprisingly, plan sponsors are getting angry! What’s particularly galling to many is that they have no intention of going bankrupt, and therefore see no value in paying exorbitant premiums to cover previously failed plans. Maddeningly, in the miraculous world of government math, the premium increases are also counted as revenue to offset general spending bills. Never mind that a dollar paid to a retiree can’t possibly be used to build a road or subsidize a student loan. Somewhere along the line, the premium started feeling like a tax. A tax applicable only to sponsors of defined benefit plans subject to increase without notice.
Even though it is Congress raising the premiums, plan sponsors have begun treating “PBGC” as a four-letter word, and then liberally clustering other four-letter words around it in conversation. (To a layperson, the distinction is often not made since both entities fall under the banner of “government”.)
Seeing PBGC premium levels as unjust, plan sponsors are looking for any way possible to reduce them. Paying lump sums and purchasing annuities are valid considerations to reduce plan size, but analysis shows their impact on premiums for underfunded plans is often minimal (and could even be negative).
In the long term, the only way to control premiums is to reduce unfunded liability and keep it from reappearing. This can be done either through strategies such as liability driven investment (LDI) hedging, or by using the aforementioned lump sums and annuities when funding ratios are more favorable. Many will ultimately choose to terminate their DB plans in favor of defined contribution (DC) programs which have no premiums at all: increasing risk for both plan participants and the PBGC.
In the short term, plan sponsors have two tactical options for saving a few bucks on premiums. One is to assign plan contributions made during the first 8½ months of the year to the prior plan year (called a “receivable contribution”). This increases the asset value used in the unfunded liability calculation, reducing the premium by 1.4% of the receivable amount this year (3% in 2016 – not a bad no-risk rate of return.)
The second is to consider switching the method used in calculating the liability from “alternative” to “standard.” Many sponsors are eligible for a free switch to the standard method in 2014, which could reduce premiums by as much as 50% for that year. The decision is locked for five years though, so sponsors should analyze the potential impact on future years before deciding. Generally, the standard method produces lower premium values in periods of rising rates, and higher premiums when rates are falling.
More Premium Increases?
Amazingly, another premium increase is expected to be considered by Congress as a revenue offset for future spending bills, even though recent PBGC projections forecast significant improvement in their deficit level. (Apparently, the four-letter words haven’t been uttered loud enough to be heard up to this point.) The Principal Financial Group® is collecting plan sponsor signatures from their clients to include in a letter from the American Benefits Council to Congress voicing dissent against future increases and encouraging others to contact their congressional representatives directly. Maybe an earlier, less profane response will be more successful this time.
Mike Clark is a fellow of the Society of Actuaries (SOA) and a member of the American Academy of Actuaries (AAA), as are many of his colleagues who work at the PBGC who are actually very nice people and have nothing to do with the premium increases, so please keep your dissent within the bounds of good taste!
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