“The tendency was to take a compliance mindset to PBGC premiums and pension plan funding,” says Brian Donohue, a partner and actuary at Chicago-based pension consultancy October Three.
In other words, premium payments were seen as a necessary cost of doing business for employers offering defined benefit plans — do what you have to do to pay what has to be paid and get the problem off sponsors’ desks until the next round of premiums are owed.
But that so-called compliance mindset has lulled some pension sponsors into a pattern of complacency, resulting in upwards of $700 million in PBGC premium overpayments between 2009 and 2016, according to a new study authored by Donohue and his team at October Three.
Premium payments have become an increasingly expensive fixed cost for pension sponsors over the years. In 2003, single-plan pension sponsors paid about $1 billion in premiums to PBGC. But rate increases mandated by Congress have exploded that figure. In 2011, PBGC took in $2.1 billion in premium payments for single plan pension sponsors. By 2016, premium revenue was $6.4 billion.
And another 25 percent to 50 percent increase is scheduled between now and 2019.
“PBGC premiums now dwarf the other operational costs of sponsoring a pension plan,” said Donohue. “If a sponsor is hoping for a 6 or 7 percent return on pension assets, and they are paying 1 percent of assets to PBGC premiums, that is considerable problem.”
In 2015, October Three estimates that $145 million in premium overpayments were concentrated among roughly 3,000 plans with at least 250 participants.
The reason for the overpayments can be found in the bowels of what Donohue calls “esoteric” pension accounting and premium assessment rules. Jumbo pensions tend to have the internal resources to sift through the rules and apply them to their advantage.
But smaller and midsized plans are often left to their own limited devices, and many may not be receiving best practice services from some pension consultants.
“We don’t see the problem as being the fault of plan sponsors—this is an area where they really have to rely on their service providers,” said Donohue. “Among jumbo plans, we tend to see best actuarial practices applied. But a lot of smaller plans are definitely missing opportunities.”
Under plan accounting rules, sponsors can minimize PBGC premiums by maximizing “grace period” cash contributions to a plan, or contributions that are allowed after the end of a plan year but are still attributable to that year.
To the layman, that may sound a bit wonky, and perhaps explains why some sponsors are not taking full advantage of how to time and report cash contributions to their plans.
But in the actuarial world, “there is nothing new in these techniques,” explained Donohue. “It’s not as if this is secret knowledge consultants don’t know about.”
In the case of some plans reviewed by October Three, all quarterly funding contribution requirements could have been applied as grace period contributions, but were not. The result is that those plans reported lower plan asset values than they could have, causing them to pay higher PBGC premiums than needed.
In one glaring example from the data October Three pulled from open-source Form 5500 information, a pension with $330 million in assets and 8,300 participants paid a variable rate premium of $2.9 million in 2015. But the plan did not record its contributions under the grace period rule, resulting in an overpayment of $685,000 in PBGC premium. While complex to the naked eye, an actuary could have recorded the adjustments in a matter of minutes, according to October Three. Actuarial fees to the plan’s consultant in 2015 were $160,000.
“Any sponsor experiencing recording errors is likely not being told the opportunity exists by their actuary and, in turn, is missing an opportunity to reduce their PBGC premium,” the report notes.
Beyond recording errors, some sponsors are missing the opportunity to reduce premium liability by accelerating contributions to plans. Over time, October Three says that strategy results in insignificant funding costs that are more than paid for by savings in PBGC premiums.
Skyrocketing premiums are forcing more sponsors—and actuaries—to apply best practice accounting standards to control premium risk. But October Three’s evidence suggests that at least half of plan sponsors without best practices in place are overpaying an aggregate of $100 million in annual PBGC premiums.
The bottom line from Donohue’s vantage is a set-it-and-forget it approach to funding strategies will continue to negatively impact PBGC rates for many sponsors, as premiums continue to increase between now and 2019.
Sponsors need to be engaging consultants on an annual basis—at a minimum—on whether they are applying the most beneficial funding and documentation strategies to their plan, says Donohue.
“We know there are sponsors out there that are not getting the service they should be getting,” said Donohue.
The good news for sponsors is that deeper access to data and transparent analysis of best-in-class accounting procedures can be expected to be a “big leveler” for all plans, no matter their size, says Donohue.
“Sponsors should be expecting more, and not feel at the mercy of their service providers,” added Donohue.