At a time when many sponsors of single-employer defined benefit plans are struggling to keep their pensions afloat, they could be overlooking opportunities to save tens or hundreds of thousands of dollars, even millions, by fine-tuning the way they account for their liabilities.
That’s the conclusion of an analysis by October Three, a Chicago-based actuarial and retirement plan consulting firm. “The PBGC Premium Burden: What Every Pension Sponsor Needs to Understand” is based on an analysis of trends in single-premium plan PBGC premiums from 2009-2016. The study estimates that sponsors paid $145 million more in premiums in 2015 than they needed to.
Actuaries to blame?
“It’s hard to blame plan sponsors for this,” says Brian Donohue, a partner of the firm. “It’s very technical, and they are relying on their actuaries.”
The overlooked opportunities described in the report are more typically found in smaller and mid-sized plans, he notes. However, the analysis did reveal that even some jumbo plans aren’t immune; one missed out on an opportunity to save $6 million a year, Donohue says. More typical is the opportunity for plans in the $100-$200 million funds to save around $100,000 a year, he adds.
What gives rise to the savings opportunity in part is the skyrocketing pace of PBGC rate increases. In 2011, PBGC premiums paid by single employer pensions totaled $2.1 billion. Last year the total was $6.4 billion. “For many employers, these premiums represent the single biggest source of pension overhead cost and a major obstacle to successful pension management,” according to the study.
The October Three analysis highlights the distinction between increases in PBGC premiums based upon the funding status of a pension — which is relevant because the savings opportunity is a function of the level of premiums paid.
Rocketing PBGC premiums
For example, premiums of an overfunded plan with 1,000 participants, $60 million in assets and a $50 million PBGC vested liability, would have risen “only” by 88 percent, from about $34,000 in 2009 to $64,000 in 2016. But an underfunded plan with the same number of participants, $40 million in assets and a $50 million BPGC funded liability would have seen its premiums jump 194% from $124,000 to $364,000 over the same period.
Scheduled increases in the two components of PBGC premiums — the flat and variable rate constituents — point to more of the same in the years to come.
The key to minimizing the PBGC premium burden — despite those additional projected increases — is optimizing the timing and recording of corporate pension funding contributions. “Minimizing PBGC premiums depends on plans’ maximizing the use of ‘grace period’ contributions — amounts contributed to a plan after the end of the plan year but still attributable to that plan year,” according to the study.
The failure to take full advantage of grace period contributions has resulted in overpayment of PBGC premiums.
“In many cases,” the report states, “all or part of contributions made to satisfy quarterly contribution requirements could have been characterized as grace period contributions, but weren’t.”
The consequence of the reported timing of the contributions is the pensions reported lower asset values than they could have and, as a consequence, paid higher premiums than they otherwise could have.
Also, many sponsors analyzed by October Three could have cut their premium cost by “modestly” speeding up some budgeted contributions. “Over a period of years, differences in contribution amounts due to modest acceleration are insignificant, but the PBGC premiums are not,” the report points out.
Seizing the opportunity to trim PBGC premium costs by optimizing the timing and characterization of plan contributions will not change a DB plan sponsor’s decision over whether or not to maintain, freeze or terminate its pension, Donohue maintains. But, he adds, at a time when low interest rates are boosting pension funding costs — on top of the rapid rise in PBGC premiums, even for well-funded plans, “you’ve got to be ruthless about reducing overhead costs.”
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