Tag Archives: PBGC premiums

Reverse spinoff considerations for pension sponsors

Plan sponsors are employing clever approaches to minimize Pension Benefit Guaranty Corporation (PBGC) premium obligations. While some approaches legitimately address both flat-rate and variable-rate premiums, other approaches are problematic. For example, one approach called a “reverse spinoff,” uses a “two-step transaction” to exploit two perceived loopholes in rules that are only intended for new plans and terminating plans in existing PBGC regulations.

The PBGC has not issued formal guidance on the reverse spinoff approach. However, given the language used in a recent PBGC staff response to a practitioner-submitted question, there is significant cause for concern upon thorough examination of the reverse spinoff approach. Milliman’s PJ Davis provides some perspective in this article.

Tax reform provides incentive to accelerate pension contributions

The end of 2017 saw the passage of significant tax reform in Congress. With this tax reform, the corporate tax rate has dropped from 35% to 21%, generating quite a bit of attention due to the significant savings that will result for corporations. One relatively unpublicized result has been the additional funding of cash contributions to corporate defined benefit plans.

While contributions made for the 2018 plan year will generally be deducted at the new lower corporate tax rate of 21%, contributions for the 2017 plan year will generally be deducted at the higher rate of 35%. For many corporations with underfunded pension plans, contributing additional dollars or accelerating already planned contributions will generate a net tax savings because underfunded plans are expected to eventually require additional contributions.

More and more, the plan sponsors are issuing corporate debt to make additional pension contributions. For example, General Electric recently announced that it was making a discretionary contribution of $6 billion into its pension plan funded through debt.

In addition to recent tax reform, here are three other reasons we are seeing this trend on the rise:

1. Skyrocketing Pension Benefit Guaranty Corporation (PBGC) premiums. The variable rate premium that corporations pay on underfunded liabilities has increased from 3.4% of the underfunding in 2017 to 3.8% in 2018 (and 4.2% in 2019, as listed in the PBGC website). Any contribution in 2018 to the pension plan immediately reduces the PBGC premium by 3.8% in 2018 (and more in future years). Additionally, that money would then be invested and anticipated to grow with the plan’s expected return (say 6.25%). This leads to an effective return on capital of 10.29% in 2018 (and 10.71% in 2019), and higher returns are anticipated in future years.
2. Updated mortality will drive PBGC liabilities higher by approximately 4%, leading to significant increases in the variable rate contribution.
3. Corporate interest rates remain low and corporations are able to borrow at relatively low costs.

For the purpose of example, let’s look at a theoretical additional contribution of $10 million into an underfunded pension plan. This additional contribution would:

• Reduce fees paid to the PBGC by $380,000 in 2018 (and $420,000 in 2019, and growing in following years)
• Be invested in the trust, and therefore would be anticipated to grow by a company’s expected return on assets in 2018 (likely 5% to 7%, which translates to $500,000 to $700,000 on a full-year basis)
• Reduce the Financial Accounting Standards Board (FASB) accounting expense in 2018 and beyond (by an amount similar to investments in the trust, depending on timing)—to the extent these contributions were anticipated at the beginning of the fiscal year
• Be tax-deductible at the 2017 corporate tax rates because any contribution before September 15, 2018, can count as a 2017 plan year contribution for calendar-year plans

However, there are some limitations:

• While plans that are fully funded on a PBGC basis will not see additional PBGC savings, they will see the additional tax and expense savings as outlined above
• Because of the structure of the PBGC variable rate premium, additional contributions to plans at the PBGC variable premium cap (due to head count) may not share the PBGC advantages, but will see the additional tax and expense savings as outlined above

With tax reform now in place, many corporations are poised to take advantage of opportunities to improve the financial status of their defined benefit retirement plans. Acting sooner rather than later on this opportunity will enable them to stabilize and move their plans more firmly into the black.

Potential solutions for reducing PBGC premiums

Defined benefit (DB) plan sponsors continue to seek options to reduce their Pension Benefit Guaranty Corporation (PBGC) premiums, especially the variable rate premium. Milliman actuary Bret Linton highlights the following three solutions for plan sponsors to consider in his article “The challenge: Reducing PBGC variable rate premiums.”

1. Additional contributions, credited to the prior plan year.
2. Borrowing capital at a lower interest rate than the PBGC variable rate.
3. Splitting the pension plan into two plans: one with only actives and a second with the remaining retirees and terminated vested participants.

A review of 2017 PBGC premium rates

carnaval-nicholasThe Pension Benefit Guaranty Corporation (PBGC) recently released the premium rates for the 2017 premium filing year. Each defined benefit plan sponsor must pay annual premiums if insured by the PBGC. Sponsors of single-employer and multiple-employer plans pay premiums consisting of two parts: (1) a flat-rate premium (FRP), equal to a fixed dollar amount per plan participant, and (2) a variable-rate premium (VRP), based on a percentage of unfunded liability. The latter part is limited by a cap that acts akin to the FRP, where the VRP cannot exceed a fixed dollar amount per plan participant. Multiemployer plans are only subject to the FRP.

Single-employer and multiple-employer plan sponsors will incur a 2017 FRP of $69 per plan participant (a 7.8% increase from the $64 premium paid in 2016). The 2017 VRP has increased to 3.4% of unfunded liability (a 13.3% increase from the 3.0% rate paid in 2016). The per-participant cap on VRPs increased 3.4% from $500 to $517 for the 2017 premium filing year.

Since 2012, single-employer and multiple-employer plan sponsors have seen sharp increases in PBGC premiums, which were written into funding relief rules under the Moving Ahead for Progress in the 21st Century Act (MAP-21) and subsequent relief under the Bipartisan Budget Act of 2015 (BBA). These laws called for scheduled increases in premiums along with indexing for inflation. Flat-rates have nearly doubled since the pre-MAP-21 level of $35 per plan participant in 2012; while the variable-rate of 3.4% has almost quadrupled since 2012. Such sharp increases in the variable-rate have resulted in VRPs approaching the more modestly increasing per-participant cap introduced by MAP-21 for many plan sponsors. This makes de-risking strategies that reduce the number of plan participants (such as terminated vested lump-sum windows and annuity purchases for retiree populations) more attractive. This is because reducing the number of participants in the plan decreases the FRP and may also lower the VRP if limited by the cap.

Being limited by the per-participant VRP cap can offer some advantages to plan sponsors hypersensitive to cost volatility. De-risking strategies such as spin-offs and partial plan terminations have been developed to reduce premiums and target these advantages. Capped VRPs are generally less volatile than uncapped VRPs. Such premiums are based on participant counts, which are likely to be relatively stable from year to year (and are actually expected to decrease in a plan with frozen participation). They are not subject to the market volatility inherent in asset returns and liability, which is determined using market-related interest rates. Capped VRPs are also not subject to the sharp scheduled increases outlined in BBA. They are subject to increases due to inflation, which are typically more modest than the scheduled VRP increases.

Multiemployer plan sponsors will also incur higher 2017 PBGC premiums. Taft-Hartley plan sponsors will experience an increase in FRPs of 3.7% from $27 to $28. The 2017 level represents a 211% increase over the 2012 PBGC premium rate of $9 per plan participant. Large increases in premiums were enacted through the Multiemployer Pension Reform Act of 2014 (MPRA) as a response to the PBGC’s dire multiemployer program situation. According to a recent issue brief from the American Academy of Actuaries, the program is projected to become insolvent within eight years partly due to historically inadequate premiums. As a result, the PBGC will not be able to support fully guaranteed benefits for troubled multiemployer plans.

The 2017 premium filing year will not be the last time rates increase; more premium rate increases are scheduled in the future. All PBGC premium rates will increase because of inflation; however, the FRP and VRP for single-employer and multiple-employer plans have additional scheduled increases. The FRP for single-employer and multiple-employer plans is scheduled to increase to $74 and $80 per plan participant in 2018 and 2019, respectively (ultimately a 129% increase over the 2012 level). The VRP is scheduled to increase to 3.8% and 4.2% of unfunded liability for 2018 and 2019, respectively (ultimately a 367% increase over the 2012 rate). Multiemployer premiums are currently only indexed to inflation with no scheduled escalations. However, according to the same issue brief from the American Academy of Actuaries, increases of around six times current levels would be necessary for the program to remain solvent through 2035, with even larger increases needed for longer-term solvency and protection from adverse experience.

The 2017 PBGC premium rates represent a significant increase from where they were only five years ago. This has led to the development and implementation of various de-risking strategies aimed at reducing the cost of maintaining defined benefit plans. Due to regulated increases, anticipated inflation, and uncertainty within the PBGC’s multiemployer program, higher premiums are expected for years to come.

PBGC proposes late payment penalty relief

Hagin NeilThe Pension Benefit Guaranty Corporation (PBGC) insures the pension benefits accrued by participants covered under private-sector defined benefit pension plans in the event the employer sponsoring the plan becomes insolvent. If a plan sponsor is unable to meet its benefit obligation to participants, the PBGC will pay the pension benefit, but only up to certain limits established under Department of Labor regulations.

PBGC collects premiums from the employers, i.e., plan sponsors, in order to provide this federally mandated insurance. The premium for single-employer plans has two components: a flat dollar (flat rate) premium, which is simply a flat dollar charge for each participant covered under the plan, and a variable rate premium, which is a percentage of the deficit between the pension assets and the actuarially determined pension obligation (also referred to as the “unfunded vested benefits”).

Recent pension law changes have increased both the flat and variable premium rates used to determine the total annual premium paid to insure single-employer defined benefit plans. As a result, plan sponsors are and will be paying substantially higher premiums than they have in the past. For example, the flat rate premium in 2012 was $35 per participant; in 2016 it is $64 per participant, and will increase to $80 per participant in 2019. In 2012 the variable rate premium was $9 per $1,000 of unfunded vested benefits. For 2016 the variable rate premium is $30 per $1,000 of unfunded vested benefits and will increase to at least $41 in 2019.

A consequence of the dramatic rise in PBGC premiums is that the penalty for submitting premium payments after they are due, i.e., filing late, has also increased, as the penalty imposed by the PBGC is determined as a percentage of the unpaid premium. Currently, the penalty for plan sponsors that self-correct an underpaid filing is 1% per month (capped at 50%) of the unpaid amount. A plan sponsor can self-correct a late filing as long as the PBGC has not notified the plan sponsor that there is or may be an underpayment. For plan sponsors that receive notice from the PBGC that there is, or may be, an underpayment, the penalty is 5% per month (capped at 100%) of the unpaid amount.

The PBGC recently proposed a reduction to the penalty amount to reduce the financial burden imposed on plan sponsors. The proposed rule change would reduce the penalty by 50%; the self-correcting penalty will be reduced from 1% to 0.5% per month with a 25% cap and from 5% to 2.5% per month with a 50% cap for filings in which the PBGC gives notice.

The PBGC also proposed creating a new penalty waiver for plan sponsors that have a “good” compliance history and that act promptly to correct any underpayments. A plan would be considered to have a good compliance history if payment of all premiums for the five plan years preceding the year of the delinquency was made on time. A late payment would not be assessed against a plan if the PBGC did not require payment of a penalty (e.g., when an entire penalty is waived). The PBGC would consider the correction to be prompt if the premium shortfall for which the penalty is assessed was made good within 30 days after the PBGC notified the plan in writing that there was, or might be, a problem. If both of the conditions are met, the PBGC will waive 80% of any resulting penalty. Under this scenario, the penalty would be reduced from 2.5% per month to 0.5% per month, which is the same amount as if the plan had self-corrected.

This proposal could drastically reduce the financial burden imposed on a plan for underpaid and late filings. For example, a plan with a $1 million premium that is two months late (after notice from the PBGC) would have a $100,000 penalty (two months at 5% per month times the amount outstanding) under the current regulation. Under the proposed regulation, this penalty would be reduced to $50,000. The penalty could be further reduced to $10,000, if the plan is eligible for the compliant plan partial waiver of 80%.

Comments on the proposal are due to the PBGC by June 27, 2016. Only after the comments are reviewed and finalized will plan sponsors know when these new reduced penalties would be effective. Until then, plan sponsors are urged to file on time to avoid the mandated penalties.

UPDATED: PBGC will collect data on pension plan de-risking measures

Herman-TimThe 2015 premium filings to the Pension Benefit Guaranty Corporation (PBGC) requires the reporting of information about the de-risking activities of pension plans as part of their annual premium payment filings. The data set includes participant counts split between participants in and not in pay status for both lump-sum windows and annuity purchases in the last two years. For lump-sum windows, the participant counts include those eligible for the window and the actual number who elected a lump-sum under the window. For annuity purchases, the participant counts are limited to those for whom an annuity was purchased. If accurate data are not available, then reasonable estimates are acceptable. Finally, data are not required to be reported if the lump-sum window closed or the annuity purchase was made less than 60 days before the premium filing is made. So for a calendar year plan that files the 2015 premium filing on October 15, 2015, the information to be provided encompasses de-risking activities from January 1, 2014, through August 16, 2015.

It will be interesting to watch what the PBGC does with the information it collects. According to the PBGC, it is interested in collecting this data because “information about risk transfers is critical to PBGC’s ability to assess its future financial condition.” Back in 2013, Joshua Gottbaum, then executive director of the PBGC, reported to the ERISA Advisory Council that pension plan lump-sum cash-outs to retirees are like cigarettes: they are legal, many people like them, and they are bad for you. With the current financial condition of the PBGC and its role in protecting participants’ pension rights, it may be that the PBGC is interested in providing more detailed regulation on the de-risking activities of pension plan sponsors.

During the past several years, we have seen many of our clients undertaking both lump-sum windows and looking into annuity purchases. For the 2014 year-end accounting disclosures, historically low interest rates combined with updates to mortality assumptions have driven up the calculated pension obligations. As a result, companies will be reporting very large pension deficits on their balance sheets. Because of the impact of pension plans’ funded status on corporate financial statements, the interest of companies in de-risking activities will continue and may even increase from prior levels.

Please contact a Milliman consultant to discuss if lump-sum windows are right for your situation.