When a company spends money in order to make money, that can be, and often is, viewed as a positive. But when a company spends money as a cost of compliance, no CFO or controller, in my experience, thinks that’s a good thing. To the extent it’s done, it’s merely a necessary evil.
One of the best examples of those evils is PBGC premiums. In the past five years, premiums paid by single-employer pension plans have more than tripled, from $2.1 billion in 2011 to $6.4 billion in 2016 — and they will rise by an additional 25% to 50% by 2019.
That’s an unsettling trend, to be sure. But also unsettling is that many companies are paying significantly more than they have to.
For those unfamiliar, the Pension Benefit Guaranty Corp. is a quasi-governmental organization that insures corporate pension benefits. As such, sponsors of corporate defined-benefit plans generally are required to pay premiums annually to the PBGC to cover its cost of providing that insurance.
From a corporate standpoint, those premiums provide no benefit. Companies pay them only because they are required to under ERISA, the 1974 law that established the PBGC and provides the framework for qualified retirement plans. So, it seems fair to say that if a company is paying even $1 more per year than it absolutely must to the PBGC, it may be spending its money needlessly and for no benefit.
How does this happen? Why is it that companies are paying more to the PBGC than they need to? In order to understand how this happens, it’s useful to give brief background on the calculation of PBGC premium amounts (using 2017 rules). There are two components:
- The flat-rate premium equal to $69 per participant in the plan.
- The variable rate premium equal to the 3.4% of the plan’s unfunded vested benefits (UVB), if any, but limited to $517 per participant.
Let’s consider the variable rate premium in a simple brief example, showing clearly how a simple strategy can save a company a pile of PBGC premium dollars. The strategy outlined below is as easy as ensuring that your actuary records your contributions to your plan strategically. Note that while it will work for almost all plans, there are a very limited number of technical situation where it may not be feasible.
|Company 1||Company 2|
|Actual plan assets as of 1/1/2017||$1 billion||$1 billion|
|Present value of vested benefits (premium basis) as of 1/1/2017||$1.4 billion||1.4 billion|
|Unfunded vested benefits as of 1/1/2017||$400 million||$400 million|
|2017 quarterly contribution on 4/15/2017||$100 million
attributed to 2017 plan year
attributed to 2016 plan year
|2017 quarterly contribution on 7/15/2017||$100 million
attributed to 2017 plan year
attributed to 2016 plan year
|Plan assets on 1/1/2017 after reflecting quarterly contributions||$1 billion||$1.2 billion|
|Unfunded vested benefits on 1/1/2017 after reflecting quarterly contributions||$400 million||$200 million|
|2017 Variable Rate PBGC Premium||$13.6 million||$6.8 million|
Company 1 and Company 2 each sponsor pension plans with identical characteristics and identical levels of funding. Each contributes $100 million on both April 15 and July 15, 2017.
But Company 1 records the contributions as being for the 2017 plan year, while Company 2 records them as being for the 2016 plan year (which is often permissible for contributions made within eight and a half months after the end of the plan year).
This simple difference in attribution has reduced Company 2’s 2017 variable rate PBGC premiums by $6.8 million. That’s a big enough number for any company that it doesn’t get lost in the rounding.
I imagine you’re wondering if this sort of overpayment happens. In fact, it does. And, according to a comprehensive study done by October Three looking at PBGC premiums paid by every PBGC-covered, single-employer defined-benefit plan in the United States with at least 250 participants, it happens very frequently.
In fact, if we were to add in other premium-reduction strategies that were considered in the October Three study, more than 65% of those plan sponsors paid more in variable rate premiums for 2015 (the most recent year for which data is available) than they may have needed to.
Unfortunately, if you’ve overpaid in the past, there’s nothing you can do about it now. But there are a few things plan sponsors should want to know:
- Did we overpay in the past?
- Should we have known how to avoid it? Or should we rely on getting optimal advice from our actuary?
- The strategy outlined above seems pretty basic. Might we be missing other effective strategies?
While the strategy laid out above is pretty simple, there’s another one that would work for many companies that can be equally effective, but has a little more complexity to it. (Remember, contributions made within eight and a half months after the end of the plan year can be attributed to the previous plan year.)
Quarterly contributions (for plan sponsors required to make them) are due for calendar-year plan years on April 15, July 15, Oct. 15, and the following Jan. 15. Let’s consider Company 2, which in the example above is making $100 million quarterly contributions. Suppose that instead of making its $100 million third-quarter contribution on Oct. 15, it accelerates the payment to Sept. 15. Then, it generally can be counted in plan assets as of Jan. 1, 2017, saving an additional $3.4 million in PBGC premiums.
Is it worth it? I certainly think so, at least in most situations. Suppose Company 2 has to borrow that $100 million for an extra month in order to make the contribution by Sept. 15. Further suppose that the company’s borrowing rate is 6% per year (pretty high for 2017). Then the cost of borrowing $100 million for one month is 0.5% of $100 million, or $500,000. Stated differently, that’s an expenditure of $0.5 million to instantly save $3.4 million.
PBGC premiums have no value to the organization paying them: the plan sponsor. And if I might be paying too much, I’d certainly want to know about it and how to stop doing it.
John Lowell is a partner with October Three, a retirement consulting firm. He is currently president-elect of the Conference of Consulting Actuaries. He can be reached at email@example.com.