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Breaking the PBGC Premium Hike/Funding Relief Cycle

Absent a congressional solution to the problem of perpetual PBGC premium increases, what can an individual DB plan do to reduce the burden of those increases? A recent white paper offers two suggestions.

In “Go Big or Go Home: Strategically Coping with Escalating PBGC Premiums,” LDI Strategies’ Colyar Pridegen argues that “seemingly relentless rounds” of PBGC premium hikes “mean that sponsors habitually utilizing the relief tend to get burned” and offers a look at how one may “lessen the sting.”

Pridegen says it all began with the “worst imaginable timing” of the Pension Protection Act of 2006’s pension funding requirements, which took effect in 2008, just as the Great Recession hit. He notes that there has been some relief, however, with the initial contribution minimums being “effectively declawed by seemingly endless waves of pension funding relief.” However, he says, the catch is PBGC premium hikes.

“PBGC premiums, both FRP [flat-rate premium] and VRP [variable-rate premium], have increased dramatically in recent years,” writes Pridegen. “No longer generally considered to be an administrative burden of immaterial cost, these premiums increasingly factor in to high level corporate financial strategy.” Not only that, he says, the 2017 and 2018 premiums can be “seen not as exorbitantly elevated compared to years gone by, but as temporarily discounted rates, slated to rise to their terminal levels by 2019, thereafter subject only to any applicable indexing.”

Reducing Premiums

There are two ways to substantially reduce PBGC premiums, says Pridegen:

Pension Headcount Reduction. Pridegen says that the easiest and most efficient way to accomplish this is through bulk lump sum windows for terminated vested participants. In saying so, he assumes “that retiree obligations can be taken out at par relative to the vested benefit obligation,” but that in practice, “additional funds likely would be needed to cover the insurance premium and make the remaining participants whole regarding funded status and benefit security.”

Pension Deficit Reduction. Pridegen notes that capital market dynamics, as well as simple time, can have a significant effect on how large a plan funding surplus — or shortfall — will be. He cites the importance of employer contributions in “achieving riskless PBGC premium savings,” which he said are assumed to reduce the deficit by an amount equivalent to the contribution immediately.

But Pridegen doesn’t stop there. He also argues that plans which are substantially underfunded and aspire to “straightaway dampen the growing toll of PBGC premiums in any meaningful way,” likely will not realize progress through modest contributions, although mildly underfunded plans may see some success.

Pridegen suggests thinking bigger, and “engaging with insurers to shave down the participant headcount on the books, or with debt markets to borrow the funds needed to shore up the plan’s finances through contributions.” Pridegen adds a caveat that “these are not actions to be taken lightly” since the process of reducing payments to the PBGC may entail facing additional costs during interactions with other parties.

“Rising PBGC premiums are certainly strengthening incentives to take action,” says Pridegen, but one should appreciate that irrevocably contributing to the plan or permanently transferring obligations can come at the expense of availability of options. “Generally speaking, options have greater value when uncertainty is high, such as when a new and active administration takes office, backed by party majorities in both houses of Congress, but having not yet communicated a vision for defined benefit plans or the PBGC,” he says. “In such an environment,” he says, it may be best to leave doors open.