With the third major pension funding relief law passed in just over three years, defined benefit plans seemingly occupy a charmed position on the legislative docket. Plan sponsors investigating the details of the latest relief bill, however, may find it somewhat less charming than its predecessors.
The most recent round of DB rules changes arrived within the Bipartisan Budget Act of 2015 (BBA), signed into law by President Obama on Nov. 2, 2015. BBA follows hot on the heels of the Highway and Transportation Funding Act of 2014 (HATFA) and the 2012 passage of the Moving Ahead for Progress in the 21st Century Act (MAP-21).
All three recent pension funding relief laws contain two main elements:
1) Interest rate relief: Permission to use higher interest rates in the calculation of the funding target liabilities used to determine minimum contributions and plan funding ratios. Higher interest rates mean lower funding targets and smaller contributions … relief!
MAP-21 pegged funding interest rates to a percentage of 25-year average high quality corporate bond rates. This percentage started at 90% in 2012 and was scheduled to phase down to 70% by 2016. HATFA and BBA subsequently extended the period for which the higher rates would be applicable. BBA now locks in the rate at 90% through 2020 (see exhibit below).
2) PBGC premium increases: Before MAP-21, the flat rate Pension Benefit Guaranty Corporation premium was $35 per person and the variable rate premium was 0.9% of unfunded plan liabilities (calculated without taking aforementioned interest rate relief into account).
By the time BBA is fully effective in 2019, the premiums will have climbed to $80 per participant plus a variable rate premium of 4.1% of unfunded liabilities (quadrupled+!), both indexed to inflation. (See exhibit below.)
Note that a percentage is by definition already indexed, so increasing the variable rate portion for inflation inappropriately double-indexes. This mathematically incorrect feature continues to appear in each successive relief law, despite repeated comments.
As a token of mercy, the variable rate premium is capped at $500 per participant (also indexed to inflation from 2016). A growing number of plans, those with large unfunded liabilities relative to their head counts, are expected to hit the cap over the next several years.
Diminishing relief returns
You can understand plan sponsors’ declining zeal when you realize that potentially lower contributions are always conjoined with significant offsetting increases in PBGC premiums. After three rounds, the pain of premium increases has begun to surpass the benefit of interest rate relief for many.
When MAP-21 passed shortly after the financial crisis, plan sponsors were more than happy to make this exchange. At the time, persistent low-interest rates figured to make minimum contributions exceedingly burdensome in an already challenging business environment.
Enthusiasm waned somewhat for HATFA as the crisis started slipping into memory, and the magnitude of PBGC premium increases began to be recognized. Still, the extension of interest rate relief was appreciated by most as corporate bond rates persisted near historic lows longer than expected.
Also see: "Best practices for retirement plan RFP success."
Today, however, many plan sponsors have already adopted funding policies in excess of the required minimums. For them, there are no funding savings from BBA, just a higher PBGC bill to pay.
Perhaps the most surprising aspect of BBA is how surprising it was. In a retirement industry teeming with in-the-know Hill watchers vying to be the first to release explanatory white papers, the law made it to the floor for a vote almost undetected. Literally passed around midnight, BBA stealthily and expediently delivered more relief to plan sponsors and the PBGC.
However, it is debatable whether either group wanted it. Plan sponsors had come to accept the funding requirements of HATFA, and were not actively seeking an extension. The PBGC’s own forecasts indicated that the single employer insurance program was likely to dig out of its deficit by 2025 without additional premium increases. (The nearly insolvent multi-employer insurance program, however, was unaffected by BBA.)
Driven by revenue
BBA and its predecessors are not pension bills specifically. Rather, they are broad spending packages covering all manner of government responsibilities: infrastructure, student loans, military, etc. Under congressional rules, additional spending must be covered by new revenues.
Perhaps due to reduced public attention as traditional pensions become scarcer, the single-employer DB retirement system has become an easy target for raising revenue. Broad tax increases to cover extra spending require lengthy debate and legislative fortitude. Raising revenue through DB regulation is politically more palatable, as the changes only impact a minority of employers in the U.S.
According to the government’s forecasts, the pension provisions of BBA are expected to raise $8.1 billion over the next decade to cover other spending projects. Roughly $1.5 billion of this comes from lower employer tax deductions driven by interest rate relief. Assuming employers behave as the accountants expect, this general tax revenue could actually be used for designated spending programs, though the amount is modest by federal budget standards.
Also see: "Mortility meets volatility in pension market."
About $4 billion of revenue comes from PBGC premium increases. This is more problematic, as this money should remain guarded within the coffers of the PBGC’s single premium insurance program. As such, it shouldn’t be physically available to fund road projects or F-35 joint strike fighter contracts.
The remaining $2.6 billion of revenue is the most troubling. A seemingly insignificant clause moves the PBGC premium deadline up one month for the year 2025. For calendar year plans, this changes the due date from Oct. 15, 2025 to Sept. 15, 2025, which just happens to fall two weeks before the end of the 10-year revenue forecast horizon. Not one additional dime of revenue is generated, but it now falls on the right side of the budgetary bright line to be counted.
Unintended plan sponsor reaction?
Much to the budget makers’ chagrin, employers may make rational economic choices that reduce government revenue estimates on both counts. With plan sponsors understanding that minimum funding rules are less relevant with each passing round of relief, PBGC premium avoidance has become a primary driver of pension funding decisions.
Many plan sponsors are considering contributing significantly more to their plans, reducing burdensome variable rate premiums and increasing tax deductions in one fell swoop. The scale of PBGC premium increases is also driving plan sponsors to pursue de-risking through lump sum windows, and even to accelerate their plan terminations.
As a result, BBA may not deliver the funding relief, PBGC premiums or budget revenues originally intended.
But hey, that probably won’t be apparent until after Sept. 30, 2025.
Clark is a consulting actuary at the Principal Financial Group, an investment management and retirement leader. He is a fellow of the Society of Actuaries (SOA) and a member of the American Academy of Actuaries (AAA), so you can understand why he gets so upset when he sees bad math. A version of this blog originally ran on The Principal blog.
The subject matter in this communication is provided with the understanding that The Principal is not rendering legal, accounting or tax advice. You should consult with appropriate counsel or other advisers on all matters pertaining to legal, tax or accounting obligations and requirements.
Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group (The Principal), Des Moines, IA 50392.
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