The MarketsAugust 1, 2012

Consider PBGC Premiums Before Reducing DB Contributions

Advisers must consider the most effective ways to help sponsors take action under legislation that reduces required funding for defined benefit (DB) plans but increases their insurance premiums.

Reported by Corie Russell

Many plan sponsors use a 24-month average of interest rates to determine the plan’s funding target and annual cost. The new law, Moving Ahead for Progress in the 21st Century Act (MAP-21) (see “Congress Passes Bill with Pension Funding Relief”), prevents the average from moving more than 10% away from a 25-year average of corporate bond rates for 2012. After 2012, the corridor widens 5% per year, eventually reaching 30% on either side of the long-term average in 2016 and later, according to Principal Financial Group.

Under the new law, the funded status of an average plan could improve by 10% or more in 2012, which would reduce the 2012 annual contribution cost. However, Mike Clark, consulting actuary at Principal, told PLANSPONSOR that this legislation will “significantly” increase Pension Benefit Guaranty Corp. (PBGC) premiums, so plan sponsors may want to continue keeping their plans well-funded by contributing more than the minimum required under the legislation (see “DB Sponsors Have Incentives to Keep Plans Well-Funded”).

Plan advisers must understand how plan sponsors view this law, Clark said. Do they see it as a benefit, or as a detriment because it leads to higher long-term PBGC premiums? Plan sponsors and advisers should discuss what option would lead to more savings.

Clark explained that plan sponsors must take both components of the PBGC premiums into account before taking action:

1. Flat-dollar premium: In 2012, single-employer defined benefit plans pay flat-rate premiums of $35 per participant with future premiums indexed for inflation. Under the new law, these premiums will increase to $49 per participant in 2014 with indexing thereafter, Clark explained.

2. Variable-rate premium: Under the law, the PBGC variable-rate premium that is assessed on each $1,000 of unfunded vested benefits will more than double by 2015. The more unfunded liability a plan has, the more will need to be paid to the PBGC to fill the deficit resulting from plans defaulting in the past.

The increase in flat-rate premium could increase the incentive for a plan to cash out terminated participants, and the increase in variable-rate premiums could increase the incentive for a plan to avoid unfunded vested benefits, according to a bulletin from Sibson Consulting. But if plan sponsors reduce the number of participants in the plan, it will not necessarily just save the $49 rate per participant, Clark said. “The variable-rate premium needs to be considered, as well,” he added.

The law will prompt many plan sponsors to consider settling obligations to get participants out of a plan, but they must realize that settling these obligations can change the funding position of the plan, Clark said.