Possible PBGC premium increase

April 06, 2011

In the Obama Administration's current budget, PBGC's premium setting process is expected to raise $16 billion over 8 years. Some estimate that under this proposal total PBGC premiums would double. House Republicans are also said to be considering an increase in PBGC premiums.

In this article we briefly review the issue of PBGC premiums and what is at stake in the emerging bipartisan movement to raise them.

Calculating PBGC premiums

Under ERISA, the calculation of PBGC premiums comes in two parts. First, all plans must pay a per-head amount -- $35 for 2010 -- for each participant in the plan. Second, sponsors of plans that do not have sufficient assets to pay vested benefits must pay a "variable premium" equal to 0.9% of every dollar of "unfunded vested benefits." So, for instance, the sponsor of a plan with $100 million in unfunded vested benefits would, in addition to the per-head "regular" PBGC premium, have to pay a variable premium of $900,000.

PBGC's deficit

The Government Accountability Office puts PBGC's deficit at $23 billion. Here's GAO's description of the state of PBGC's finances:

PBGC's deficit fluctuates due to various factors, including changes in interest rates, investment performance, and losses from completed and probable plan terminations. ... As of September 2010, PBGC held approximately $79.5 billion in assets and approximately $102.5 billion in liabilities -- for an accumulated deficit of $23.0 billion, more than double the deficit from 2 years earlier .... This growth in its deficit was due largely to an increase in plan terminations and a decline in interest rates used to value PBGC's liabilities.

There is a lot of controversy over the actual size of PBGC liabilities. Probably the most significant issue is the interest rate used to value liabilities. PBGC's valuation interest rate is based on a survey of annuity prices, producing, generally, a valuation interest rate much lower than the corporate bond yield curve used to value plan liabilities for funding purposes. In financing insured benefit payments, PBGC does not actually have to go out and buy annuities. Instead, it manages its own portfolio (the $79.5 billion referred to in the GAO report) to finance those liabilities. Critics argue that use of unnecessarily low valuation rates greatly overstates the difference (the deficit) between how much PBGC has and how much it will have to pay.

Who will pay

Part of what is at stake in the debate over PBGC premiums is the issue of who will have to pay for underfunded DB plans. There are really two issues here. First -- should taxpayers generally have to bail out the DB system? It is clear that there is a firm, bipartisan consensus that they should not.

The second issue is, if there are higher premiums (that is, higher costs inside the DB system), which sponsors will pay them? There are a number of different ideas circulating at this time. One, obviously, is to simply raise the risk-based premium -- that is, increase costs on underfunded plans only. Another is to increase premiums on financially weak companies; it appears that bond or credit ratings might be used to separate the weak from the strong here. A third is to increase regular premiums and in effect tax the DB system as a whole for the anticipated deficit.

Let's note a couple of things here. First, the proposal to charge higher premiums based on the credit condition of the sponsor is unusual. There were proposals, during the debate over the PPA, to adjust funding (the at-risk rules) based on the financial condition of the sponsor, but those proposals were rejected by Congress. Now, with respect to PBGC premiums, this same concept has come up again -- that there should be one set of rules for financially "sound" companies and another, tougher set for those whose finances are less "sound."

Second, the issue about which sponsors should pay increased premiums has the potential to divide the plan sponsor community. How this issue is fought out is of critical importance to all sponsors and to the sponsor community as a whole. In the past, generally, there has been unity among sponsors -- the financially sound and less-sound, those with well-funded and less well-funded plans, standing together. Attacking the proposed increase as unnecessary, because PBGC's deficit is exaggerated, maintains that unity. But if policymakers are determined to significantly raise premiums, then that unity could fragment.

Budget hocus pocus

There is another issue lurking in the PBGC premium controversy coloring the entire debate. PBGC premiums function like a tax. They are treated as revenues and are part of the unified federal budget. So, the $16 billion in new PBGC premiums anticipated in the Administration budget "enhances" revenues. From one point of view, that's $16 billion of cuts -- e.g., to military or social spending -- that don't have to be made. The possibility that an increase in PBGC premiums will help the federal budget as a whole certainly accounts for some of its bipartisan appeal.

Prospects

At this point it's unclear where any of this is going. As we have said a number of times before, in the current situation -- divided government and severe budget strain -- there are basically two possibilities. First, that the two parties will simply sharpen their arguments during 2011 in anticipation of taking the budget issue to the electorate in 2012. Or, second, that they decide to work together on a compromise solution to the budget "crisis."

If we are in gridlock, then any action before 2012-2013 is unlikely. Although, given that there is some measure of bipartisan support for increased premiums, it's still possible that as part of some one-off piece of legislation (like last year's Doc-Fix), an increase in PBGC premiums could be included as a revenue raiser.

If the parties decide to sit down and negotiate a budget solution this year, then certainly the issue of a PBGC premium increase will be on the table. As will a number of other pension issues.

We will continue to follow this issue as it develops.

October Three, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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