When the Bipartisan Budget Act of 2015 was signed into law in November 2015, it extended pensions stabilization rules for three years, making it easier for defined benefit (DB) plan sponsors to get approval to use mortality tables other than that prescribed by the U.S. Treasury, but it also increased, once again, the Pension Benefit Guaranty Corporation (PBGC) fixed- and variable-rate premiums.
The flat-rate premium for PBGC insurance coverage of a pension funding shortfall increased by another 25% over the following three years, while the variable rate will rise closer to 35%. This means annual fixed-rates by 2019 will rise to $80 per participant, while the variable rate will rise to 4.1% on unfunded vested benefits.
For example, take a plan with 2,000 retirees with 500 of those retirees receiving a pension from this plan of less than $2,000 per year. The expenses alone to keep them in the plan, including PBGC premiums, is approximately $300 per year.
The rising pension funds are definitely scaring plan sponsors, says Robin Solomon, partner, Ivins, Phillips & Barker in Washington, D.C. “Plan sponsors are trying to reduce head count in order to lower PBGC obligations,” she says. “This year, in particular, we’ve seen record stock market returns. Most categories of equities have had positive returns so far this year and plan funding has benefited as a result.”
But there is another side of this equation, Solomon says, namely “interest rates, which are used to calculate pension liabilities. Even though the stock market has gone up, pension funding has not improved that much because interest rates have remained unusually low for a long period of time.”
David Hinderstein, president of Strategic Retirement Group, Inc. in White Plains, New York, says, “PBGC premiums are still front and center for each plan sponsors overall expenses on the DB plan along with taxation and funded status and finding ways to derisk their DB liabilities.
“The more aggressive steps you can you can take to eliminate expenses on a traditional DB plan the go directly to the improved funding status,” he says. “But in addition, small balance cash outs, lump sum offerings and aggressive pension risk transfer (PRT) to insurance companies have also increased as plan sponsors have a greater understanding of their liabilities.”
Pension Risk Transfers
The reason there are more PRT lump sums or buyouts is not only about the PBGC rate increases, according to Michael E. Devlin, principal, BCG Pension Risk Consultants, in Boston. “Funding levels are the best they’ve been pre-2008 due to the rise in the stock market,” he says.
In addition, “There is the combination of interest rates increasing and the implementation of the new Internal Revenue Service (IRS) mortality tables, which reflect a longevity measurement more in sync with insurance carrier assumptions. Tie this in with increased PBGC fees, and you see why plan sponsors are actively exploring and implementing these derisking strategies.”
When plan sponsors derisk, Devlin explains, they no longer have to pay for several expenses such as: the custodian on the account, the issuing of the 1099, the PBGC fees, plus the plan has eliminated the stock market risk, longevity risk, and interest rate risk.
Devlin says that companies like BCG Pension Risk Consultants, Mercer and Willis Towers Watson had been annuitizing DB funds on a plan termination basis, and now we’re seeing a tremendous amount of plan sponsors doing it on a non-termination basis.
Improving Funded Status
Improving a plan’s funded status also helps lower PBGC premiums plan sponsors have to pay for unfunded vested benefits.
Hinderstein says the stock market has improved funded status and it is a better time for plan sponsors to unload liabilities. But his advice for plan sponsors is that “with rising interest rates, plan sponsors should make sure that their assets and liabilities are tied together and that they understand the impact to their funded status of a rising interest rate environment.”
If the plans assets and liabilities are not tied together, and interest rates climb and asset rates fall, they could have a larger gap in their funded status, says Hinderstein. How can a plan sponsor change this? He says, “This can be changed by performing an asset liability study that would indicate where their liabilities are and matching assets up to their liabilities—a task that the plan’s adviser does.”
Solomon’s firm works with companies on how to improve their funded status. She says that for companies that have been relying on funding relief and have only made the minimum contributions to the plan, it’s very difficult to improve the funding status based on stock market gains alone.
“We work with companies to look for creative funding strategies. There are many ways to fund a pension plan that does not require cash. One such solution is contributing real property or employer securities to the plan. Another is contributing Treasury bills to the plan instead of cash. These could be Treasuries held by the company already, or purchased for this purpose. A contribution of T-bills may be more attractive to company executives because unlike a cash contribution it is not reported on their financial statements as a use of operating cash flow. A DOL exemption is required, but we work with clients to obtain the necessary exemption from the prohibited transaction rules.”
In some cases, Solomon adds, to reduce liability DB plans can be mitigated by making certain changes to pension plan design–even without making any additional contributions to the plan.
Brian Donohue, partner at October Three Consulting, based in Chicago, in late 2017 wrote an article for PLANSPONSOR about how a defined benefit (DB) can be split up into two plans. One plan covers participants subject to the variable-rate premium headcount cap, and the other, a plan that covers all other participants. This may reduce the PBGC variable-rate premiums in two ways.
However, it should be noted that the PBGC has revised the 2018 comprehensive premium filing instructions, hardening its position against what is sometimes referred to as the “spin-term” strategy for reducing variable-rate premiums.
Solomon says, “Transactions to improve the funding of the plan is in the participants’ best interest. It makes the plan more secure, and it certainly reduces the employer’s obligation to pay PBGC variable rates, which are extremely costly.”
« HSAs: An Increasingly Important Retirement Benefit to Consider