PBGC Premium Increases: How Plan Sponsors Manage the Burden

Defined benefit plan sponsors are used to managing risk in terms of asset value volatility or minimum funding requirements. But one of the biggest threats to benefit plans is the continually rising premium costs paid to the agency that insures these plans.
As Pension Benefit Guaranty Corp. (PBGC) premiums continue to increase, we examine some ways plans sponsors can address the risk of rising costs within their plans.


Premium Primer

The Pension Protection Act of 2006 (PPA) changed the premium payment structure that plan sponsors pay to the PBGC. These premiums ensure that if a company becomes insolvent, the PBGC will step in and pay the promised benefit to each participant.
Plan sponsors may need to pay two premiums to the agency. The first is a flat rate premium, which is similar to an insurance payment. It will rise to $83 per participant in 2020, up from $80 in 2019. The second premium, called a variable-rate premium, is paid when a plan has missed a designated funding level. This number is significant in 2020 at $45 per participant for every $1,000 in unfunded vested benefits (UVBs) and will be capped at $561 for each participant. In 2019, this rate was $43 per participant, with a $541 cap.
Investment returns and liability discounting rates affect funding levels, and during periods of heightened volatility plan sponsors may be forced to choose between paying the variable rate or increasing contribution levels to keep the plan solvent. Sometimes it is possible for plan sponsors to shift budgeted contributions to an earlier period to reduce PBGC premiums.
While volatility is always top-of-mind for plan sponsors, steep premium rate increases are keeping plan sponsors up at night as well. Since the PPA was enacted, rates for single-employer plans have shot up 137 percent for flat-rate premiums, and 400 percent for variable-rate premiums. Multi-employer costs for flat-rate premiums will increase to $30 per participant in 2020, from $8 in 2007.
In response to rising premiums and other market trends, many plan sponsors are choosing to reduce their exposure to the risk of maintaining a defined benefit plan. According to the Bureau of Labor Statistics, 39 percent of defined benefit plans are in some way frozen—either to new employees or new accruals. But even frozen plan funding levels are subject to ups and downs that trigger variable rate premium increases.


Ways to De-Risk Pension Plans

Because plan sponsors have seen the variable rate nearly double in the past five years, they are looking at ways to de-risk their plans. Plan sponsors are revisiting and combining multiple strategies to offload risk from their defined benefit plans. Reducing the headcount and liabilities within the existing plan helps remove the risk of having to pay exorbitant premiums. Many organizations choose to de-risk in waves, when terms are more favorable to complete certain parts of the overall strategy.
One approach is to offer lump-sum payments to terminated vested participants who have not yet started to take their benefit. This is a voluntary option for participants and can be an effective way to reduce headcount and plan obligations. Employees can take their benefits as a lump-sum, or roll assets into an Individual Retirement Account (IRA). It can be a preferred strategy because the cost to offer a lump-sum can be equal to or less than the plan sponsor’s obligation or liability.
A second method is to buy group annuity contracts from an insurance carrier for existing and terminated vested employees. Plan sponsors do not need employee approval for this strategy. This also may be a good option for those paying the per-participant cap for their unfunded liabilities.
In fact, 40 percent of plan sponsors told the Secure Retirement Institute (SRI) that they were interested in pension plan buyouts in 2020. The company reported U.S. corporate pension plan buyout sales equaled $7.7 billion, up 23 percent from 3Q 2018.
A third option, called a buy-in, is seeing a resurgence in popularity. This is a form of Liability Driven Investing (LDI), where the plan sponsor purchases a group annuity contract, just like a buy-out. With a buy-in, however, the plan sponsor remains in control of the assets, but is reimbursed by the insurance company for monthly payments. The insurance company assumes the risk for the benefits it insures. Plan sponsors looking to have more control in timing of a future buyout may want to consider this method.

BDO Insight: De-Risking is Not One-Size-Fits-All

Defined benefit plan premium costs continue to be expensive and unpredictable, so it is not surprising that plan sponsors are looking for ways to reduce or eliminate this burden.
Considering when and how much to de-risk may be just as important as determining which method to use to transfer liabilities off the organization’s ledger. There are other non-financial issues to consider, such as how the transaction may affect company culture, recruiting and workforce retention.
Your BDO Representative can help you work through the many options and outcomes de-risking may yield for your organization.