New Premium Rates
The PBGC recently released its defined benefit pension plan single-employer premium rates for plan years beginning in 2017. The flat-rate premium increases to $69 per participant, up from $64. The variable-rate premium increases to $34 per $1,000 of unfunded vested benefit liability, up from $30. The cap on the variable-rate premium increases to $517 per participant, up from the 2016 cap of $500 per participant.
The table at the bottom breaks down the premium rates for the 2017, 2018 and 2019 plan years, as projected by the PBGC.
As long as a pension plan is maintained, plan sponsors will have to pay the flat-rate premium. However, the variable-rate premium is only imposed if a pension plan has unfunded vested benefit liability under the PBGC required calculation method.
Managing Premium Hikes
Given the established and projected increases, pension plan sponsors are encouraged to adopt strategies that will help curb these additional costs and protect their plans. There are two approaches that can help control PBGC variable premium costs:
1. Use Some Form of Pension Risk Transfer
Pension risk transfer means that a pension plan transfers its risk (actuarial liabilities, investment risk, longevity risk and interest rate risk) to someone else. The two most common methods involve offering lump-sum cash outs to terminated vested participants or purchasing annuities from an annuity company. Under either approach, a substantial portion of a pension plan’s risk is transferred to its participants or to an annuity company.
There are some downsides to this approach. Even with the minor increase in interest rates since November 2016, the cost of the lump-sum cash outs and annuity premiums will be significantly greater than the corresponding actuarial value of the liabilities of these benefits being transferred, as determined under the Internal Revenue Service (IRS) minimum funding regulations. This could require additional employer contributions to maintain a pension plan’s funding level.
Another potential issue with pension risk transfer is that it might trigger “settlement accounting” disclosures on corporate financial statements. Under settlement accounting, pension plan sponsors are required to accelerate the recognition of pension gains or losses in their annual earnings statement. A recent example involved Verizon Communications Inc., which disclosed that a settlement accounting for their pension plan resulted in a $555 million charge to earnings.
2. Fully Fund the PBGC Vested Benefit Liability
The PBGC vested benefit liability can be fully funded in one of two ways. One approach is to substantially increase annual pension contributions, causing the PBGC pension liability deficit to amortize over a short time period. While it is rapidly amortizing, the pension plan will still be subject to the PBGC variable rate premium, but the objective is to reduce the deficit faster than the rate of increase in the variable rate premium.
Another option is to borrow the amount of the unfunded PBGC pension liability deficit and contribute it into the plan. There are valid reasons to consider borrowing to fully fund the vested benefit liability, such as:
- To take advantage of attractive interest rates in the credit markets.
- To eliminate the variable-rate premiums of 3.4% of the unfunded vested benefits (which are likely to increase to 3.8% in 2018 and 4.2% in 2019).
- The amount borrowed will likely be tax deductible when contributed to the pension plan.
- The interest paid on the loan will likely be tax deductible.
- Pension plan sponsors can replace what is typically a volatile debt obligation (the PBGC unfunded vested benefit liability) with a known debt obligation that has fixed loan payments. Note: this last advantage is partially based on the assumption that, working with the pension plan’s investment consultant, plan sponsors modify the investment allocation to reduce investment risk and volatility.
A Little Planning Can Go a Long Way
Higher insurance premiums for single-employer defined benefit pension plans threaten to weaken the private retirement system. However, with the right strategy in place, pension plan sponsors can lessen the burden. As the increases have a greater impact, SilverStone Group’s Defined Benefits Team can provide pension plan consulting designed to help manage and maintain PBGC premium costs for years to come. The increases have started – the time to act is now.
Single-Employer Plan PBGC Premium
This article originally appeared in the 2017 | ISSUE ONE of the SilverLink magazine under the title “Rates are Rising”. To receive a complimentary subscription to the SilverLink magazine, sign up here.