Evaluating PBGC Premium Options in Advance of Big Increases

Which door to choose?Each year, defined benefit (DB) pension plan sponsors must pay pension insurance premiums to the Pension Benefit Guaranty Corporation (PBGC). In light of large PBGC premium rate increases in 2013 and future years, plan sponsors should carefully evaluate their options before proceeding with their next premium payment.

Background

There are two components to annual PBGC premiums:

1. Flat rate premium based on the number of participants

2. Variable Rate Premium (VRP) based on the plan’s unfunded vested liabilities

As a result of last year’s Moving Ahead for Progress in the 21st Century Act (MAP-21), PBGC premium rates are scheduled to increase sharply over the upcoming years. Below is a table showing a summary of upcoming PBGC rate increases.

MPGC rate table 2013

Potential Strategies to Manage PBGC Premiums

Pension plan sponsors generally don’t like to pay PBGC premiums because it is money that could otherwise be spent on increased funding for the plan. With this in mind, here are some important issues to consider before proceeding with your next PBGC premium filing:

1. Unfunded liabilities for the VRP can be calculated using “standard” PBGC interest rates (snapshot rates) or “alternative” rates based on a 24 month average of the snapshot rates. Once you choose a method, you have to stick with it for at least 5 years. Since 2008 was the first year that plan sponsors could elect the “alternative” method, 2013 is the first year that they can make an election to switch back to the “standard” rates (though it likely won’t be advantageous to do so).

2. Over the long-term, both interest rate methods should produce similar VRP amounts even though the smoothed alternative interest rates will lag the standard rates. When interest rates are falling, VRPs based on the alternative interest rates should be lower than those using standard rates. The opposite will be true in a rising interest rate environment.

3. Sponsors of small pension plans (fewer than 100 participants) that haven’t completed their 2012 PBGC premium filing can actually lock-in beneficial VRPs for two years. Their 2012 premiums aren’t due until April 30, 2013 so they can estimate their 2012 and 2013 premiums under both the standard and alternative methods and see which one is the most economical.

4. Before switching interest rate methods just to get lower 2012 and/or 2013 VRPs, plan sponsors should be aware that it’s less expensive to be underfunded now than in 2014 or later years. That’s because the VRP premium rate is doubling in the next two years (see table above), which could wipe out any short-term VRP savings this year.

How could this strategy backfire? Consider a plan that switches to the alternative VRP method in 2013 in order to lower their unfunded liability by $1M. This would decrease their 2013 VRP by $9K (i.e., $9 per $1,000 in unfunded liability).

Now suppose that interest rates increase before 2014. The standard interest rate method would immediately use those higher interest rates to calculate 2014 VRPs. The alternative rates would lag and be lower than the standard rates, which would produce higher unfunded liabilities. Let’s suppose that the alternative method 2014 unfunded liability is now $1M higher than using the standard method. This means that the alternative method 2014 VRP would be $12K higher (i.e., $12 per $1,000 unfunded liability since the VRP rate increases in 2014) and you end up with a net loss of $3K on VRP for the two plan years.

Next Steps

What’s a plan sponsor to do? The 5-year commitment to the “standard” or “alternative” interest rate method means you can’t guarantee lower PBGC VRPs using one or the other. However, you should evaluate your options each year. If cash is tight and interest rates are on the move, it may be worth choosing one method or the other for some short-term PBGC premium savings with the knowledge that doing so could expose you to higher premium rates in upcoming years.

Déjà Vu All Over Again: PBGC Extends Reportable Event Relief for 2013 and Beyond

PBGC logoIn what has become an annual rite of winter, the PBGC recently released PBGC Technical Update 13-1 extending relief from the proposed amendments to the reportable events regulations for certain small pension plans. However, unlike previous years’ relief, the new technical update provides guidance for all plan years after 2012 (or until new proposed or final rules are released) and not just a one-year extension.

Summary of Important Guidance

Similar to the prior pronouncements, the new Technical Update:

– Extends the waiver of the requirement to report a missed quarterly contribution for small pension plans under ERISA §4043.25. This waiver is valid as long as the plan (1) has fewer than 25 participants or (2) has between 25 and 100 participants and files a simplified notice with the PBGC. In both cases, the reason for the missed quarterly contribution cannot be due to financial inability.

– Affirms that the assets and liabilities used to calculate the PBGC variable rate premium should be used to determine reporting requirements for events occurring during the following plan year. This includes determining whether the plan is eligible for reporting waivers, reporting extensions, or is subject to advance reporting requirements.

Of course, the relief in Technical Update 13-1 will be superseded once the PBGC issues  final rules.

After four years of temporary reportable event relief, it seems likely that the new proposed regulations will eventually incorporate some of this relief on a permanent basis. At the very least, Technical Update 13-1 provides the stability of knowing that reportable event relief will continue until new rules are released and that we won’t have to wait for the PBGC to reaffirm the relief annually.

MAP-21: Good News & Bad News for Pension Plans

The “Moving Ahead for Progress in the 21st Century” (MAP-21) legislation signed into law last week included significant pension law changes.  These included good news and bad news for sponsors of defined benefit pension plans.

The good news is that MAP-21 provided some relief from the historical low interest rate environment.  The funding segment interest rates (which are based on 24 month average rates) will now be restricted to a range around the 25 year average rates.  That range is 10% for 2012, ramping up to 30% for 2016 and beyond.  This effectively increases the funding interest rates for 2012, which can significantly lower the liability and minimum contribution requirements from what they otherwise would be.

The bad news of MAP-21 is sharp increases in PBGC premium rates.  The fixed and variable rate premiums will increase as shown in the table below.  Rates will also be indexed for inflation.

Certain plans will also need to disclose the effect of the stabilized interest rates to participants on the Annual Funding Notice.  This applies to plans with 50 our more participants, a funding shortfall of $500,000 or more (based on rates without stabilization), and stabilized Funding Target less than 95% of the Funding Target without stabilization.

It’s important to note that the interest rate changes are optional for 2012.  Some plans, like professional firm cash balance plans, will not benefit from the interest rate changes and can avoid the expense of restating their 2012 valuation results.

Many plans will want to take advantage of the option to calculate the minimum contributions with the stabilized rates.  Those that do will have the option to measure funded status for benefit restriction purposes with or without stabilization.  MAP-21 does not allow the stabilized rates to be used for 2012 benefit restrictions without also using them for the minimum contribution calculation.

The interest rate stabilization of MAP-21 will not apply to the minimum lump sums under §417, maximum deductible contributions, PBGC variable rate premiums or PBGC §4010 reporting.  Pension accounting under FASB ASC 715 is also not affected.

Additional guidance from the IRS is needed to determine the exact impact of this law change and how to implement it for 2012.  Please contact Van Iwaarden Associates if you would like an estimate of the impact on your plan or to discuss the application of these rules in more detail.