Data Spotlight: Escalating PBGC Premiums

Perspectives, June 2016

PBGC Premiums Driving Growth in Annuity Pension Risk Transfers


 

Over the last several years, U.S. pension risk transfer annuity buy-out volume has grown rapidly, driven in part by the rising costs to maintain a pension plan. A significant component has been the escalating premiums that plan sponsors must to pay to the Pension Benefit Guaranty Corporation (PBGC).  The U.S. government has passed a series of legislation over the last four years, including the most recent, the Bipartisan Budget Act of 2015, which drastically increased PBGC premiums. Hardest hit are poorly funded plans and plans with a large number of participants.

The fixed premium per plan participant, currently $64, will increase to $80 in 2019. Looking back, it was just $19 in 2005 and $35 in 2012. The variable premium (the amount paid per $1,000 of unfunded vested liability) will increase from $30 today to $41 (or higher, depending on the inflation rate) by 2019. This premium was just $9 in 2012 and didn’t exist before 1998. The variable rate premium cap of $500 per person was not changed by the 2015 Act.

PBGC Premiums Are Skyrocketing

Illustrates how the Pension Benefit Guaranty Corporation fixed premium for each plan participant has increased from 2012 to 2019, and how the variable premium for $1,000 of unfunded vested liability has also increased in that same period.

Source: PBGC and Prudential Financial Analysis.

(click here for a larger version of this chart)

HEADING: PBGC Premiums are Skyrocketing 

SOURCE: PBGC and Prudential Financial analysis.

TABLE TEXT FOR GRAPHICS:

     
  2012 2019
Fixed premium per participant $35 $80
Percentage increase in fixed premium vs. 2012   not applicable 228%
Variable premium per $1,000 of unfunded vested liability $9 $41
Percentage increase in variable premium vs. 2012  not applicable 455%

TABLE SUMMARY: Demonstrates the rapid increase in PBGC fixed and variable premiums from 2012 to 2019.

Source: PBGC and Prudential Financial Analysis.

The illustration below depicts  how a typical mid-sized pension plan with $500 million in total liability, 9,000 participants and an 80% funded status could be affected by the recent PBGC premium increases. In 2019, the plan will pay almost four times what it paid in total premiums to the PBGC in 2012.

Illustrative Mid-sized U.S. Corporate Pension Plan Premiums

Illustrates how in 2019, a mid-sized pension plan with $500 million in total liability, 9,000 participants and an 80% funded status will pay the Pension Benefit Guaranty Corporation nearly four times as much as it did in 2012.

Source: Prudential Financial Analysis.

(click here for a larger version of this chart)

HEADING: Illustrative Mid-Sized U.S. Corporate Pension Plan Premiums

SOURCE: Prudential Financial analysis.

TABLE TEXT FOR GRAPHICS:

  2012 2016 2019
Flat Rate Premium $315,000 $576,000 $720,000
(# Employees) x  (Per Person Premium)
Variable Rate Premium $900,000 $3,000,000 $4,100,000
(Unfunded Vested Liability) x (Variable Rate) 
Total PBGC Premium $1,215,000 $3,576,000 $4,820,000
Premium Per Participant $135 $397 $536
% Increase Over 2012 N/A 294% 397%

TABLE SUMMARY: Demonstrates how a typical pension plan could be affected by the rapid rise in Pension Benefit Guaranty Corporation premiums from 2012 to 2019.

Source: Prudential Financial Analysis.

By 2019, PBGC premiums will rise to $536 per participant, up from $135 in 2012. For plans with per-participant annual benefits of $500 or less, PBGC premiums can equal or even exceed actual participant benefit payments. This is a major catalyst driving plan sponsors to seek solutions to decrease their plan size—both in head count and total liability.

 

Strategies to Manage PBGC Premium Costs

Lump Sum Offerings
One method for reducing headcount and the fixed rate PBGC premium is to offer pension plan participants with a vested benefit that no longer work for the company a one-time lump sum payment in lieu of all future benefit payments. This option has gained a significant amount of popularity as the cost to the plan is currently very efficient.

Annuitize Retirees
Another option to reduce both headcount and liability is to annuitize retirees with an insurer.  Plans that can’t afford to fully buy out all plan retirees are now considering annuitizing retirees with the smallest benefits. Retirees are the most efficient liability segment to transfer to an insurer, and the small-benefit subset of retirees is particularly economical for plan sponsors as it reduces the greatest head count while maximizing PBGC premium and administrative savings.

Borrow to Fund
With the PBGC variable rate premium increasing to over 4% of the underfunded vested liability in 2019, another option plan sponsors are examining today is borrowing to fund up the plan in order to eliminate or reduce the variable PBGC premium.  

The cost of borrowing in our current low interest rate environment makes it possible for most investment grade plan sponsors and many high yield sponsors to replace pension underfunding debt with contractual, bond-like debt. Pension contributions are tax-deductible in the U.S., offering companies an opportunity to accelerate the tax deduction. In many cases, borrowing offers plan sponsors an arbitrage opportunity, while also decreasing the overall costs to maintain a plan.

Implications of PBGC Premium Increases
With three premium increases in the last four years, PBGC premiums now loom as one of the largest costs of running a defined benefit plan. As a result, the economic cost of an ongoing pension plan will increase, making a pension risk transfer transaction potentially more attractive.

 

 

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