DB Sponsors Have Incentive to Keep Plans Well Funded

July 2, 2012 (PLANSPONSOR.com) – New pension rules will reduce defined benefit (DB) plan sponsors’ near-term required contributions, but will also raise premiums to the PBGC (Pension Benefit Guaranty Corporation).

The bill provides real and material relief for corporate sponsors facing significant increases in cash contributions over the next few years (see “Congress Passes Bill with Pension Funding Relief”). That relief could be in the range of $40 to $50 billion for S&P 1500 plan sponsors for 2012 and could total well over $100 billion through 2014 according to Mercer estimates.   

The plans that would otherwise fall below key funding thresholds will now have more time to improve the funding levels and avoid restrictions on their ability to pay some accelerated benefit forms, such as lump sums. Mercer notes the bill does not change plan sponsors’ underlying pension obligations; it gives them more time to address their plans’ current funding shortfalls, many of which are the result of today’s low interest rate environment.  

PBGC premiums rise substantially for all plans and underfunded plans, in particular, will incur higher variable-rate premiums. PBGC flat-rate premiums will increase from $35 to $42 per participant in 2013 and $49 in 2014, and then will be indexed for inflation. In addition, the PBGC variable-rate premium that is assessed on each $1,000 of unfunded vested benefits will more than double by 2015.

DB Sponsor Choices  

The legislation establishes discount rate stabilization that reduces short term contributions and variability in those contributions. “This has the effect of removing a factor of uncertainty in the calculation of pension liabilities but will mean that sponsors should evaluate the effect of the changes on their pension investment policies” said Bruce Cadenhead, Mercer’s chief actuary for the US Retirement, Risk and Finance business. “In particular, sponsors for whom cash volatility management is a high priority may decide to adapt their Liability-Driven Investment policies in the short term to maximize the volatility reduction resulting from the new law. Many may also cash out terminated vested participants to avoid the increase in PBGC premiums and lower administrative costs.”  

Jacques Goulet, US leader of Mercer’s Retirement, Risk & Finance business, added: “Pension plan sponsors must fully evaluate their alternatives under the new legislation, and decide which options best fit with their strategic financial and risk management goals. Lower near-term contribution requirements will be welcomed by many plan sponsors who faced significant increases in cash contributions as they struggle to recover from the recent financial crisis, especially for sponsors with liquidity issues. On the other hand, all plan sponsors face significantly higher PBGC premiums – in particular variable rate premiums for underfunded plans will more than double by 2015. Thus plan sponsors have a strong incentive to keep their plans well funded, which means many will choose to contribute more than the minimum required under the bill.”