August 1, 2012 (PLANSPONSOR.com) - Plan sponsors must consider the most effective ways to take action under legislation that reduces required funding for defined benefit (DB) plans but increases their insurance premiums.
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”).
Clark explained that plan sponsors must take both components of the PBGC premiums into account before taking action:
- 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.
- 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.