PBGC rate hikes moving DB plans into danger zone

Sharply higher Pension Benefit Guaranty Corp. premiums resulting from the new federal budget deal will push more employers to shrink or terminate their defined benefit plans, moves that also will further erode the agency's shaky finances, industry observers said.

The budget deal approved by the House Oct. 28 and by the Senate Oct. 30 would raise PBGC premiums by more than 40% over the next four years, coming on top of multiyear increases already added as part of a 2013 budget pact.

These latest rate increases, if approved, would raise premiums from to $80 in 2019 from $64 per participant in 2016 both up from the 2015 rate of $57. Variable-rate premiums of $30 per $1,000 of underfunding would increase 37% to $41 by 2019.

“This deal confirms plan sponsors' worst fears, that Congress isn't going to stop,” said Michael Kreps, a principal with Groom Law Group, whose firm is handling what he called an unprecedented number of terminations and derisking activity, in large part because of rising PBGC premiums.

To budget negotiators trying to avoid a government shutdown or hitting the federal debt ceiling on Nov. 3, it was a matter of numbers and political necessity. At least on paper, PBGC premium increases will pay for other federal programs and avoid painful Medicare premium increases when counted as simple federal revenues. In reality, premiums go to the PBGC, not into the general Treasury.

But to defined benefit plan executives and consultants trying to help sponsors manage for the long run, being singled out year after year seems unfair and makes the future too uncertain.

“It's unfortunate that Congress pretends to balance the budget by punishing employers who offer pensions,” said Joshua Gotbaum, former PBGC director and now a resident scholar at the Brookings Institution in Washington. “Raising PBGC premiums doesn't add a dime to the U.S. Treasury, but it does give businesses another reason to stop providing pensions,” he said.

Added Alan Glickstein, Dallas-based senior retirement consultant at Towers Watson & Co.: “We got some really bad news in an area where we've had nothing but bad news. This is just going to further encourage plan sponsors to take actions to make their plans smaller” to reduce the premium bills.

Matt McDaniel, a Philadelphia-based Mercer partner who leads the defined benefit risk business in the U.S., said rising PBGC premiums have been one of the most commonly cited reasons for sponsors to offer lump-sum cashouts to vested former employees or buy annuities for retirees. “It makes that type of activity that much more compelling,” he said.

Aon Hewitt's 2015 annual benchmarking survey of 250 employers found that with the PBGC increases already on the books, including the 2016 rates, 63% of plan sponsors are acting now to control future costs, with 44% planning to reduce the number of plan participants through settlement strategies and 19% planning to increase cash contributions to avoid underfunding, which also subjects them to variable premiums.

Rick Jones, Chicago-based senior partner in Aon Hewitt's national retirement practices group, also sees premium increases spurring sponsors to adopt more liability-driven investing strategies “to minimize the potential for plans to become underfunded,” rather than risk having to pay higher variable premiums. “It will further encourage plan sponsors to consider more conservative investments,” said Mr. Jones.

Daniel Westerheide, senior vice president and co-head of beta, ALM and risk management for Segal Rogerscasey in Boston, believes there will be additional interest in derisking through lump sums and annuity buyouts, but those actions will have a relatively minor impact on underfunded plans because both assets and liabilities are reduced. Hibernation strategies using fixed income to match the interest rate risk of assets and liabilities “may be just as effective in limiting the variable PBGC cost, so there should be great interest there as well,”Rogerscasey in Boston, believes there will be additional interest in derisking through lump sums and annuity buyouts, but those actions will have a relatively minor impact on underfunded plans because both assets and liabilities are reduced. Hibernation strategies using fixed income to match the interest rate risk of assets and liabilities “may be just as effective in limiting the variable PBGC cost, so there should be great interest there as well,” he said.

The budget deal isn't all bad news for some plan sponsors, if they can take advantage of pension funding stabilization rules that would be extended until 2023, allowing them to use higher interest rates when calculating contributions. “For an organization with marginal cash resources, it could be material,” said Mr. Jones.

And large enough sponsors that want to use their own data to determine mortality tables could do so under the budget deal, which is “a needed change,” said Towers Watson's Mr. Glickstein.

But it could be ominous for the PBGC itself, critics said, if there fewer plan sponsors to pay premiums after the new premium hikes, especially the ones healthy enough to consider other options.

“I don't think that what the PBGC wants is a smaller premium base,” said Mr. McDaniel of Mercer. “We are seeing a lot of interest in funding up or borrowing the cash to fund up” to the point where a plan can be terminated. “If you look at the economics of that, it can be quite compelling,” he said. “Not every plan sponsor has the funds to do that, but every dollar of premium increases is one more reason to lead to terminations. It's exactly the kinds of plans that the PBGC doesn't want terminating — ones that are healthy and unlikely to become a burden to them.”

PBGC officials were concerned enough about losing their premium-paying base that earlier this year they started requiring employers to disclose any risk transfer information along with premiums. Derisking actions, the agency said, “lower the participant count and reduce premium income,” which could “degrade PBGC's ability to carry out its mandate.”

PBGC officials did not ask for the additional premium increases, and with the single-employer program balance sheet improving steadily in recent years, “there is really no reason to increase single-employer premiums at this time,” said Mr. Kreps of Groom.

Unlike the PBGC's multiemployer program, where a fiscal year 2014 deficit rose to $42.4 billion from $8.3 billion the previous year, the single-employer program saw its deficit shrink to $19.3 billion from $27.4 billion in the same period. The multiemployer program, which agency officials predict is likely to run out of money in 2025, did not get premium increases in the budget deal.

But some policymakers want to address the PBGC's $19 billion single-employer deficit now, and believe that plan sponsors can absorb the cost.

“Even with these changes, premiums would likely remain a relatively small percentage of a company's annual pension contribution and a tiny fraction of total compensation costs,” said an administration official who declined to be identified.

It is not tiny for the 100 plan sponsor members of the Committee on Investment of Employee Benefit Assets, Bethesda, Md., which represents $2 trillion in pension assets, whose PBGC premiums account for 13% of plan expenses. “Every year it's costing more and more, and they don't see any end in sight,” said Executive Director Deborah Forbes.

“The first statutory mandate for PBGC is to encourage the voluntary pension system,” Ms. Forbes said. “These perpetual increases for no reason other than to raise revenue for other things is not encouraging the defined benefit system; it's giving sponsors more incentive to get out.” n