There is more work to be done in encouraging employers to meet the challenges posed by Pension Benefit Guaranty Corporation (PBGC) premiums, says a recently released report, and they can use a variety of best practices to do so.
Consulting firm October Three has released its 2021 report on PBGC premium burdens, the fifth such annual report it has issued. The report is based on a comprehensive analysis of the experience of approximately 4,500 U.S. pension plans. They report that there is continued “significant improvement” in how plans and employers meet the challenge of handling PBGC premiums, but argue that more needs to be done—particularly by small employers.
Premiums
The stakes, October Three says, are high. The report says that since 2008, single-employer plan sponsors have paid more than $50 billion in PBGC premiums—and $30 billion of that has been paid in the last five years. Premiums increased precipitously from 2008 to 2017, they report; in fact, flat-rate premiums in 2017 more than tripled in nine years, and the variable rate premiums from 3.4% of unfunded liability to 4.5% of unfunded liability.
Furthermore, in 2020, 593 plans paid PBGC premiums that amounted to at least 1% of their assets, says the report. “In a world of 3% interest rates, PBGC premiums continue to represent a debilitating cost wedge for these pension sponsors,” they say.
Missed Opportunity
Since 2012, the report notes, employers have paid $500 million more in premiums than they could have; if employers had adopted best practices, they could have saved $34 million in 2019 alone.
October Three says that while it found that small employers are the most likely to not take steps to reduce their premium burden, some large employers also do not do so. One large plan, for instance, paid nearly $12 million more in premiums than it could have since 2012. Not only that, plans lost $34 million that they could have saved if they had taken action to reduce the amount of premiums they paid, the report says.
Recording grace period contributions—amounts contributed to a plan after the end of the plan year but still attributable to that plan year—for the prior year also could have reduced PBGC premiums for many plans, argues October Three. “We view these ‘recording errors’ as the most egregious failure to adopt best practices for premium management and the easiest to correct,” they say.
Not making good use of quarterly contribution requirements and not applying funding balances has resulted in plan sponsors paying higher PBGC premiums than necessary, October Three says. This, they argue, is due to not maximizing and getting full credit for grace period contributions.
Many times, they say, part or all of contributions made to meet quarterly contribution requirements could have been characterized as grace period contributions but were not. Thus, says October Three, plans often could have reported higher asset values than they did; consequently, they pay higher premiums than necessary.
“The good news is that more and more sponsors are catching on to this strategy,” October Three says. They report that in 2012, 1,912 plans paid $82 million in premiums, but by 2019, only 570 plans missed opportunities. “That’s a 70% drop in plans making overpayments and a 58% drop in overpaid premiums,” they observe.
Steps Taken
October Three reports that employers are taking a variety of steps.
Changing Calculation Methods. In 2019, they report, more than 100 employers changed how they calculated premiums from the alternative method to the standard method. But this had mixed results, according to October Three: it reduced 2019 premiums for many employers, but it increased the 2020 and 2021 premiums by more than the 2019 reduction. “Sponsors that adopted a more strategic view with respect to these elections avoided this trap,” says October Three.
In 2020, the report notes, many sponsors could do the opposite, and shift from the standard method to the alternative method. October Three concludes that, “in most cases, this move made sense for sponsors and will likely reduce overall premiums.”
Contribution Timing. Plan sponsors could defer all required contributions until the end of 2020 and include those contributions for the 2019 plan year, which October Three says reduced 2020 premiums. Many sponsors took full advantage of those rules, the report says.
Settling Liabilities. Most employers have settled liabilities and made voluntary contributions as another way to manage the growing burden of PBGC premiums. Consequently, October Three says, since 2012 the number of participants covered by PBGC insurance fell by 26%, from more than 32 million to 24 million.
Additional Suggestions
October Three argues that minimizing PBGC premiums “depends on plans’ maximizing the use of ‘grace period’ contributions.” But they make a variety of additional suggestions regarding things employers can do:
- pay attention to rules related to the timing and recording of plan contributions;
- better manage funding balances;
- be strategic in use of the standard and alternative methods for calculating PBGC premiums;
- adopt premium management practices that incorporate better recording practices; and
- modestly accelerate pension contributions to minimize PBGC premiums.
Recording practices. “The simplest strategy,” October Three argues, “involves no change in plan funding pattern at all, merely an assessment of plans’ ability to record grace period contributions for the prior year.” They caution, however, that “sometimes this can’t be done—plans that are less than 80% funded must make cash contributions to satisfy funding requirements, and other plans that don’t satisfy prior year requirements until the funding deadline (September 15 for most plans) can’t record grace period contributions optimally.”
Accelerating pension contributions. October Three suggests that a “modest” acceleration of pension contributions can help in minimizing PBGC premiums. Even accelerating them from as little as one month to five months at the most could have such an effect. And they add that while it can be complicated, employers that can estimate and accelerate voluntary year-end contributions also can reduce premiums.
- Log in to post comments