Facing increased PBGC variable premiums and potential corporate tax reform, U.S. corporations are accelerating their pension contribution schedules.
At least four companies have announced significant debt issuances in recent months, the proceeds of which are being used, at least in part, to make hefty pension contributions in 2017, surpassing the original expected contributions that had been announced in 10-K filings with the Securities and Exchange Commission.
The largest contribution was made by Verizon Communications Inc., New York, which in the first quarter made $3.4 billion in discretionary pension contributions. The contribution was funded by debt, a portion of an $11 billion offering in March that also funded the Yahoo Inc. acquisition, said Robert A. Varettoni, company spokesman, in an April 20 email.
Verizon, in its 10-K filing in February, originally said it intended to make its minimum-required contribution of $600 million during the year; the additional discretionary contribution brings the total for the year to $4 billion.
As of Dec. 31, defined benefit plan assets totaled $14.6 billion, while projected benefit obligations totaled $21 billion, for a funding ratio of 69.3%, according to the company's 10-K.
Other companies that have recently issued debt in order to fund larger-than-expected discretionary contributions are:
- E.I. du Pont de Nemours & Co., Wilmington, Del., announced in a May 2 SEC filing that it plans to contribute $2.9 billion to its U.S. defined benefit plan in 2017, partially funded by new bonds totaling $2 billion. The company in its 10-K filing in February originally said it intended to make $320 million in contributions in 2017.
- FedEx Corp., Memphis, Tenn., offered $1.2 billion in new bonds at the beginning of 2017, $1 billion of which was set to be used to fund pension contributions. The company's fiscal year began on June 1.
- Delta Air Lines Inc., Atlanta, contributed a total of $3.2 billion to its defined benefit plans in March and April, it said in an April 12 SEC filing. The amount was well above the $1.2 billion the company had announced in its 10-K filing on Feb. 13. The funding of the larger contribution came from $2 billion in unsecured, investment-grade debt the company issued during the first quarter.
Tax reform a trigger
Several consultants posit that the emergence of potential corporate tax reform, a key point in President Donald Trump's campaign for the presidency, might have been a chief trigger to inspire companies to make larger pension contributions.
“The fact is there is a potential belief or hope or expectation around tax reform, and whether tax reform will include with it any change in the ability to contribute to pension plans on the same tax-deductible basis we do now,” said Ari Jacobs, Aon Hewitt senior partner and global retirement solutions leader.
While corporate tax reform is far from a certainty, the administration's initial proposal called for the reduction of the corporate tax rate to 15% from 35%. Whether the reduction is that steep, observers said, there will likely be a reduction of some kind.
Current tax law allows a plan sponsor to deduct a portion of its pension contributions based on its tax rate.
“If I'm paying taxes currently and I can get a 35% deduction in the money I put in my plan now vs. a 15% or 20% deduction in the future, it's a lot cheaper to make that contribution now,” Michael Archer, Philadelphia-based senior consultant and leader, client solutions group, North America retirement, at Willis Towers Watson PLC, said in a telephone interview.
Adding to that incentive, Mr. Archer said, is that companies have until Sept. 15 to report retroactive deductions for the prior plan year.
“Some organizations will act sooner,” Mr. Archer said, noting companies don't want to take the risk of a drop in the corporate tax rate.
Joe Nankof, founding partner, head of capital markets/asset allocation at Rocaton Investment Advisors LLC in Norwalk, Conn., agreed the potential for tax reform could be a catalyst in corporations choosing to make large contributions now.
“If (the rate) goes down to 25% or 20%, then you're looking at the after-tax cost of funding the plan goes from 65 cents for every dollar to … it could be to 85 cents to 75 cents for every dollar on an after-tax basis,” Mr. Nankof said. “You'd rather pay 65 cents than 75 cents.”
Richard McEvoy, New York-based partner and head of the financial strategy group at Mercer LLC, said that large contributions will continue for some time.
“All kinds of sponsors are looking at pretty significant contributions over the next few years as funding relief expires,” Mr. McEvoy said, referring to the 2012 Moving Ahead for Progress in the 21st Century Act.
“The contributions are coming home to roost, if you will. Coupled with that, if corporate tax rates come down, so do corporate tax deductions, so that makes this year a good year in part if you assume that in future years, contributions won't be as tax-favored.”
Variable rates going up
Mr. Archer said a major reason large contributions are occurring this year is the increase in the variable rates the Pension Benefit Guaranty Corp. will charge U.S. corporate pension plan sponsors.
The PBGC's variable rate is based on the unfunded obligations in a defined benefit plan, as opposed to the fixed rate, which is based on the number of participants in the plan.
“That (variable) rate for 2017 is now $34” per $1,000 of unfunded vested benefits, Mr. Archer said. “It's going to be $38 next year with potential indexing above that, and $42 in 2019, and again with potential indexing (to inflation) above that.”
“Sponsors are loath to pay those premiums,” Mr. Nankof said. By paying large contributions into the plans, Mr. Nankof said, it helps the funded status, reduces the premium to be paid, and ultimately goes to the participants.
“If you pay a variable premium out of a plan it doesn't do your participants really any good,” Mr. Nankof said. “It's something that plans don't really want to do.”
An added bonus is that with corporate funding ratios improving, companies gain further ability and incentive to continue derisking their plans and ultimately the ability to transfer out of their plans entirely, sources said.
One hurdle, for example, to group annuity purchases has been the premium. But Mr. Archer noted that the group annuity purchase business has become significantly more competitive in the past few years, which is resulting in smaller premiums on the annuities.
He also noted there were about $13 billion in group annuity purchases in each of the past two years, with the number of pension buyouts also increasing.
“They're buying out their small-benefit retirees because of the PBGC premium,” Mr. Archer said. “If you've got a retiree who's got a $100 a month benefit, you have a 6.5% or so load from just carrying that person. It's less than a 6.5% load from an insurance premium.”
Mr. McEvoy agreed that further derisking of plans is a motivator in pulling the trigger on these large contributions.
“It's the ongoing drumbeat and desire to derisk plans,” Mr. McEvoy said. “We've seen that for years, and there is a bit of a snowball effect. With these contributions, we can anticipate derisking activity to be the next shoe to drop. Pension contributions just enable more derisking and many frozen plan sponsors getting closer to exiting the plan entirely.”