The fact is: Many defined benefit plans are paying much larger PBGC premiums than necessary. Except in rare cases, these overpayments don’t arise from “errors” in the conventional sense – they arise from failure to effectively navigate the post-PPA funding and premium rules.
These premium overpayments are often significant – in the millions of dollars for some large underfunded plans, and hundreds of thousands of dollars for many other plans. With the possible exception of very small plans, the incremental consulting required to minimize premiums typically pays for itself many times over.
Moreover, recent legislation has more than tripled the PBGC variable premium rate – from 0.9% of unfunded vested benefits in 2013 to about 3% by 2016. Since overpayment amounts might reasonably be expected to triple as well, prudent plan sponsors will do well to ensure that their premiums are right-sized.
In our analysis of PBGC-filing and Form 5500 information, we found that most medium to large-size plans have been making logical decisions toward minimizing PBGC premiums – but many (over 25%) have not consistently done so. Decision-making around this issue typically involves the plan’s actuaries recommending and explaining a course of action to the plan sponsor.
Sponsors who cannot recall having conversations on this topic might want to ask their actuaries about their plan’s experience in recent years with regard to the following premium levers:
- Standard versus alternative method: The standard variable premium calculation method specifies segment interest rates from a specific month for calculating the premium liability. You can instead elect an alternative method that determines premiums from the plan’s ERISA funding liability – which is typically based on 24-month-average segment rates. Caution should be used when switching between the standard and alternative methods (in either direction), because the new method must be used for at least five years.
- Funding interest rate selection: When the alternative method is used, moving the plan’s funding interest rate selection off the default (average segment rates, zero-month look-back) can significantly impact premiums. Options are a) to change the look-back month (the reference month for segment rates), or b) to change from segment rates to a full yield curve. Such changes are basically permanent (for funding purposes), however, so this option amounts to a one-time opportunity – which should be used with the utmost discretion.
- Early-reflecting contributions: It is often advisable to treat contributions made during the first eight and one-half months of a plan year as applying toward the prior year, thereby increasing the asset value for the premium determination. (The latter year’s contribution requirements are then satisfied by using the prefunding balance that arises from these “excess” prior-year contributions.)
- Modest funding acceleration: Premium savings from early-reflecting contributions can often be enhanced significantly by modestly accelerating the payment of certain required contributions.
Given that many plans do not appear to be operating optimally within the rules, this subject deserves more attention. With ever-changing circumstances (interest rate movement, funding considerations, etc.), this is not an area where it’s ever advisable to simply repeat the actions of the prior year without considering all other options. Minimizing PBGC premiums, while not difficult, does require sustained effort – and may deliver handsome rewards. If you sponsor a defined benefit plan, talk to your actuaries and make sure you fully understand their recommendations. Make sure – really sure – you’re not overpaying the PBGC.
Joseph L. Penick, consulting actuary at Curcio Webb, LLC, can be reached at (415) 743-5692 or jpenick@curciowebb.com.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.