Mortality Bonus and PBGC Premiums Strain DBs

It’s happened before and it will happen again—a hike in PBGC premiums and shifting SOA mortality projections have materially raised the cost of running a pension plan.

New research from national pension consulting firm NEPC suggests increased lifespan projections from the Society of Actuaries (SOA) and other economic pressures, such as the recent hike in Pension Benefit Guaranty Corporation (PBGC) premiums, are seriously intensifying cost pressures on defined benefit (DB) plan sponsors.

There was already a “critical need” for liability-driven investing programs and cost-consciousness among DB plan sponsors before the most recent SOA mortality tables and PBGC premiums came into effect, Brad Smith, a partner in NEPC’s corporate services practice, tells PLANSPONSOR. From vigorous activity in the pension de-risking and buyout space to expanding interest in pension hibernation and other “bridge strategies,” Smith says there is no shortage of evidence that pension plan sponsors are feeling pinched. Add in recent news reports that the ongoing budget deal being hammered out in Washington could lead to further PBGC premium hikes, and it all makes a pretty grim picture for pension plan sponsors.

Looking over the last year, Smith says the most impactful change highlighted in his firm’s 2015 Defined Benefit Plan Trends Survey “relates to the longevity improvements released by the Society of Actuaries in their updated mortality table.” As expected, he says improvements in longevity have had a significant negative impact on plans’ funded status, with the number of defined benefit plans with a funded status less than 80% increasing to 21% in 2015—up from just 9% in 2014. Some of this is due to shaky market conditions, Smith says, but the change in mortality tables is a more permanent and profound effect.

Also as expected, a strong majority of survey respondents (69%)—predominantly large and trendsetting pension plans—said the change in SOA mortality tables has “prompted them to conduct a formal review of their hedging glide-path strategy.” Of those that conducted a review, NEPC says, 39% chose to redefine their glide-path and 10% “re-risked” or otherwise revised their strategy to take into account the updated assumptions.

NEXT: Running a DB often means ‘strained comfort’

According to NEPC researchers, although the new mortality tables prompted significant evaluation by plan sponsors, “a majority of respondents (52%) were comfortable with their current strategy and decided not to make any adjustments to their current glide-path.” 

NEPC says the findings are particularly important for participants in the Baby Boomer generation—who are likelier to be expecting a substantial private pension plan benefit in addition to any Social Security and defined contribution (DC) plan assets. At the plan level, it is actually employers with the youngest plan populations that could see the most dramatic point-in-time funded status impact based on SOA mortality projections—given the longer anticipated benefit payments lifespans of these plans. As Smith observes, most industry practitioners and medical professionals alike predict lifespans will continue to lengthen materially in the coming decades, adding additional strain to the traditional DB system.  

All of these factors continue to paint a pretty compelling picture for pension buyouts and other direct strategies to help sponsors keep control of potentially snowballing costs, NEPC says. The research also suggests that, although a majority of plan sponsors are hedging interest rate exposure using liability-driven investing (LDI) strategies, many are also taking action to reduce the absolute size of the sponsor’s pension liability by offering lump-sum distributions to a subset of participants, generally terminated, vested participants.

Smith warns sponsors to remember the Internal Revenue Service’s (IRS) new prohibition, announced in July, on certain lump-sum distributions for beneficiaries currently in payout status. Of those surveyed, NEPC says 65% of plan sponsors have offered lump-sum distributions, and 18% are planning to do so in the future.

“Annuity purchases are another option available to plan sponsors to reduce the absolute size of the pension liability,” Smith says. “Although several high profile plan sponsors have gone this route, 69% of plan respondents say an annuity purchase is cost prohibitive at this time.”

NEXT: Rocky road ahead 

“There’s no silver bullet or one-size-fits-all solution to address the needs of plan sponsors who still have their sights set on maintaining their corporate defined benefit plans,” Smith concludes. “With an eye toward the obstacles that lay ahead, we will continue to counsel clients aiming to maximize risk adjusted returns while opportunistically de-risking their plans in the most strategic and cost-efficient manner.”

It’s a sentiment shared frequently with PLANSPONSOR—though not every interested party is as diplomatic as NEPC. For example the ERISA Industry Committee (ERIC), reacting to speculation that the Congressional budget deal being crafted in Washington could involve provisions to further increase PGBC premiums as a tax revenue generator, says it “is outraged” at the proposal.

According to ERIC, the proposal being discussed by the Obama Administration and top Congressional leaders would raise the fixed rate premium from $64 in 2016—which was slated to be the final increase—to $68 for 2017, $73 for 2018, and $78 for 2019. The rate would then be indexed for inflation, ERIC suggests, adding there are also “proposed changes to the variable rate premiums of $30 per $1,000 of underfunding to $38 per $1,000 of underfunding in 2019.”

Annette Guarisco Fildes, president and CEO of ERIC, says the group is “sounding the alarm that once again the employer-sponsored system is being targeted for revenue,” adding that the premium increase is “just another unnecessary burden on employers who sponsor defined benefit plans, giving them more reasons to consider exit strategies.”

“Even the PBGC’s own analysis does not call for an increase in premiums on single-employer defined benefit plans,” Guarisco Fildes adds. “PBGC premium increases like the one announced today do nothing to encourage single-employers to continue defined benefit plans or improve benefits for retirees; in fact, the increases only work to further weaken the private retirement system.”

NEXT: Up in arms

Michael Barry, president of the Plan Advisory Services Group, is another industry practitioner who is clearly concerned with the potential for Congress to step in over PBGC’s own leadership to raise premiums.

Barry lists the PBGC-related elements of the budget proposal as follows: “It would increase PBGC flat-rate premiums (current 2016 rate: $64) to $68 in 2017, $73 in 2018 and $78 in 2019 and PBGC variable-rate premiums (current 2016 rates: $30 per $1,000 of unfunded vested benefits, subject to a $500 per participant cap) by $2 in 2017, $3 in 2018 and $3 in 2019. The proposal would also allow sponsors some latitude in using plan-specific mortality tables (in anticipation of likely IRS adoption of new tables in 2017 reflecting significant mortality improvements) and extend current interest rate stabilization relief.”

All of this serves only one purpose, Barry says, raising government revenues. “It has nothing to do with retirement policy,” he warns. “We’ve had round after round of premium increases, even though PBGC’s single-employer program deficit continues to shrink. Evidence would indicate that PBGC’s underwriting is completely out of whack—there was a $4 billion underwriting gain in 2014, a $1.4 billion increase over the 2013 underwriting gain.

In written arguments shared with PLANSPONSOR, Barry continues: “If someone would (please) take the time to study PBGC’s finances, they would see that PBGC’s ‘deficit’ (itself a questionable index of PBGC’s financial condition) is not, and for 10 years has not been, the product of underwriting losses (that is, inadequate premiums vs. claims). The deficit is the result of: (1) the failure of PBGC to hedge against declines in interest rates (understandable—a lot of sponsors similarly wish they had hedged in 2000); and (2) a chaotic, incoherent and constantly changing investment policy.”

Barry concludes that the actual result of these premium increases “is that premium revenue will go down, as sponsors bail out of the DB system because of premium increases … But Congress is in love with raising premiums because they count as revenues but don’t count as taxes. Which puts them squarely in the bipartisan crosshairs. Is there a point at which something becomes so ironic that it’s not even ironic anymore?”

For the full NEPC survey results, click here.