Pension Plans May Face Higher 2011 PBGC Variable Premiums Due to Low Interest Rates

As we mentioned in our blog post yesterday, the segment interest rates used for PBGC purposes are historically low right now. The previous post provided details of how this could affect the liabilities reported in the 2010 Annual Funding Notice to participants. This post highlights the impact on plan sponsors’ PBGC variable rate premiums (VRPs) for 2011.

The PBGC VRP is equal to .009 multiplied by the unfunded vested liability for a plan year. So, if a plan has an unfunded vested liability of $1M, then their variable rate premium would be $9,000 = .009 x $1,000,000. A calendar year plan would usually calculate its vested benefit liability based on December 2010 PBGC interest rates, so those are the rates we want to focus on.

The December 2010 rates haven’t been published yet, but we expect them to be very low based on the rate experience in recent months. For example, the November 2010 PBGC segment rates were 1.65%, 4.91%, and 6.52%. In comparison, the December 2009 rates (used to determine 2010 VRPs) were 2.35%, 5.65%, and 6.45%. As these interest rates decrease, the calculated value of the plan liability increases. This could lead to potentially higher VRPs than plan sponsors are expecting.

Some issues to consider for the 2011 PBGC VRP:

– The exact effect of the interest rate changes on a particular plan are hard to gauge. Since the largest discrepancies are in the first two segment rates, this will have a greater impact on mature pension plans where there are significant benefits payable within the next 20 years. Younger plans whose majority of benefits aren’t payable for more than 20 years may not see much interest rate impact at all.

– If plan sponsors haven’t already done so, they may want to consider using the PBGC Alternative Method for calculating the VRP liability. The Alternative Method uses the funding interest rates (which are currently higher than the PBGC rates) and may produce lower liabilities. However, use of the Alternative Method cannot be revoked for 5 years and sponsors should be aware that funding segment rates will probably be lower than the PBGC segment rates.

– The increase in plan liabilities could be offset by favorable asset returns in 2010. Higher asset values would decrease the unfunded vested liability and, therefore, decrease VRPs.