Another Factor in Favor of Pension Risk Transfers

Congress raised PBGC premiums substantially as part of the December budget deal, the second increase in the last few years.

As part of the budget deal approved in December, Congress increased the premiums that companies with pension plans pay to the Pension Benefit Guaranty Corp. (PBGC). The increases follow closely on the heels of premium hikes enacted as part of a transportation bill in 2011 (the Moving Ahead for Progress in the 21st Century Act, or MAP-21), and critics argue the higher premiums could lead more companies to lower the number of participants in their plans by buying annuities for some participants or offering lump-sum buyouts.

Plan sponsors pay the PBGC a flat premium on each participant in the pension plan; they also pay a variable premium if the plan is underfunded. The flat rate, which stood at $35 in 2012, will go from $49 this year to $57 in 2015 and $64 in 2016. The variable rate, which stood at $9 per $1,000 of unfunded benefits in 2012, will go from $14 per $1,000 this year to $24 in 2015 and $29 in 2016. Moreover, the per-participant cap on the variable-rate premium goes to $500 in 2016, up from $412 currently.

“The magnitude of these increases is just startling,” said Alan Glickstein, senior retirement consultant at Towers Watson. “The fixed per-participant premium is essentially doubling over a few years, and the variable-rate premium is basically more than tripling.”

 

Six-Figure Premiums Get Attention
Christopher Bone, director of the PBGC’s policy, research and analysis department, said in an email that PBGC premiums “are on average less than one-half of 1 percent of total employment costs.”

Alan Glickstein of Towers WatsonBut Glickstein, pictured at left, pointed out that a company whose pension plan has 10,000 participants, as many plans do, is looking at paying more than $600,000 a year in flat-rate premiums in 2016.“That’s a number that’s big enough to get attention,” he said. “It may or may not be the most important factor in their decisions, but it’s clearly going to be an influence as plan sponsors look this year at their game plan for managing pension plans.”

Kathryn Ricard, senior vice president for retirement policy at the ERISA Industry Committee, which represents large companies on benefits policies, agreed that the premium increases are a concern for companies with pension plans. “There’s no money tree in the backyard of these companies,” Ricard said. “We have heard directly from our members that these increases are certainly a factor.”

She also questioned whether the increases were in the best interests of the PBGC. In an environment where fewer and fewer U.S. companies offer defined-benefit pensions, “the last thing you want to do is continue to increase the cost of offering plans,” Ricard said. If more companies close plans or reduce the number of participants in their plans, the agency could see its premium revenue decline.

“To me, it’s a very short-sighted solution for the PBGC,” she said. “They should want to keep as many people in the pension system as possible.”

Driver of De-Risking, Not Closing Plans
Still, few see the premium increases convincing many companies to eliminate their pension plans.

The reasons that companies terminate plans include “getting large liabilities off their books and getting out of the longevity risk and investment risk that [pension plans] pose,” said Donald Fuerst, senior pension fellow at the Academy of American Actuaries. “PBGC premiums will always be on that list, but they’re relatively far down on that list, not that material.”

Bone, of the PBGC, agrees. “Many other factors are far more important, particularly the desire of companies to reduce the volatility and size of their pension costs and to reduce the risk of losses,” he wrote. “There has been a decades-long shift away from traditional pensions in favor of defined contribution or 401(k) type plans, and for most of that period PBGC premiums were very small.”

At this point, the premium increases are seen as more likely to influence decisions about risk transfer strategies, such as offering participants lump sums or buying an annuity to transfer the responsibility for some participants to an insurer.

Once a company has frozen a plan to new entrants or closed it, the plan is no longer an integral part of the company’s benefits policy, and risk-transfer options like lump-sum offers and annuity purchases may be more attractive, Fuerst said. And as PBGC premiums rise, every participant that a company gets off its books means a reduction in the premiums it owes.

“These higher premiums do incent employers to provide lump-sum distributions so they don’t have to pay the premiums,” he said. “We think that’s a bad incentive.”

Fuerst noted that the Academy of American Actuaries opposed the latest PBGC premium increases. “Lump-sum settlements, in particular, we don’t think are a good policy objective,” he said. “We think it’s generally better for a retiree to have the security of a lifetime income.”

Moreover, the higher premiums are taking effect as a number of other factors seem to be paving the way for an increase in risk transfer actions by plan sponsors, such as the sharp improvement in pension plan funding last year.

“For the first time since the Great Recession, we have some stability in the market, a more feasible annuity purchasing opportunity, and plans that are better funded,” said Glickstein, pictured at left. “If interest rates go up, that just lowers the cost of paying a lump sum. All of those things are conspiring to have 2014 shape up to be a year where we have a lot more activity.”

 

Incentive to Improve Plan Funding
Glickstein and Fuerst both said the increase in the variable-rate premium is likely to encourage underfunded companies to contribute more to their plans to improve the funded status.

The $29 per $1,000 variable-rate premium in 2016 comes to almost 3 percent, Glickstein noted. “For each dollar of unfunding that you eliminate, you get a 3 percent return on that right off the bat because you’re saving that PBGC premium.”

Drew Crouch, director of government relations at Buck Consultants, wondered whether there could be more PBGC rate increases coming down the line.

“When Congress does want to spend money, there’s a dynamic now where the cost of that spending has to be offset,” said Crouch, who served as tax counsel for the House Ways and Means Committee before joining Buck late last year. “And we also have a dynamic where it’s difficult to do those offsets with tax increases.”

The PBGC premiums in the 2011 MAP-21 law produced $8 billion in federal revenue, and the latest round of premium increases in the budget deal will raise the same amount, Crouch said. “As additional spending needs are identified, will pension provisions continue to be used?”

Page 1 of 2
Comments