Why single-plan DB sponsors paid less in PBGC premiums, despite increased rates

Sponsors of private-sector single-employer defined benefit plans paid less in premiums to the Pension Benefit Guaranty Corp. in 2018, despite the scheduled increases in the costs to insure retirement plans.

Roughly 5,000 plans with at least 250 participants account for more than 95 percent of PBGC premium revenue. Collectively, the plans paid $1.2 billion less in premiums in 2018, an 18 percent drop from 2017, according to October Three, an actuarial consulting firm.

Strong investment returns, record levels of voluntary contributions after passage of the Tax Cuts and Jobs Act, and wider adoption of pension funding and reporting best practices have improved the funding status of pensions, reducing their premium costs, said Brian Donohue, a partner in October Three’s Chicago office.

“Clearly, we are seeing better habits from sponsors, and that’s leading to better funding levels,” Donohue said. “It’s testament to the fact that sponsors are increasingly moving away from funding strategies oriented to their minimum required contributions.”

Until 2018, total premiums had increased every year over the past decade, save for a slight decrease seen in 2011. Premiums spiked by $2.2 billion in 2016.

Despite last year’s dramatic decrease, premiums to PBGC still remain a considerable burden for plan sponsors, said Donohue. The roughly $5.4 billion paid in 2018 is a 400 percent increase from the $1.3 billion paid in 2008.

During that period, Congress enacted several increases to the per-participant and variable rate premiums on pensions. PBGC does not set premium rates.

The per-participant rate was $74 in 2018, and is scheduled to be $80 in 2019. It was $33 in 2008.

Last year, the variable-rate premium was $38 for every $1,000 in unfunded vested benefit obligations, and will increase to $43 this year. It was $9 in 2008.

Variable premiums applied to underfunded liabilities have dropped considerably in the past two years. The median VRP payment was $67,000 last year, compared to $125,000 in 2017 and about $136,000 in 2016.

The increased cost of insuring unfunded liabilities has motivated an evolution in funding strategies, said Donohue. About 500 plans that owed variable premiums on unfunded liabilities in 2017 were fully funded in 2018, and did not have to pay variable premiums, according to the report.

“Sponsors are asking more questions about their premiums, and the variable rate premium is becoming the de facto funding target—that’s a very positive development,” he said.

Some sponsors still paying more than they need to

The median total premium for the 5,000 plans October Three analyzed was $225,000 in 2018. Over 600 plans paid more than $1 million in 2018.

Small plans, defined as those with 250 to 999 participants, pay higher premiums as a percentage of plan assets, particularly when they are underfunded and have variable rate exposure. Those plans with a VRP paid an average percentage of 0.80 percent of plan assets in 2018.

Large plans–those with more than 10,000 participants–paid an average of 0.50 percent of assets when they had variable premiums due. For an underfunded plan with $5 billion in assets, that amounts to $25 million in annual premium payments, the report notes.

For all plan sizes, about 40 percent are overfunded and don’t pay a variable rate premium, double what it was in 2013. About 60 percent of large plans are fully funded.

Accelerating funding

Sponsors’ voluntary contributions have been surging since 2015. About $95 billion in contributions were made to 2017 plans, as incorporated sponsors sought to write down contributions against the 35 percent corporate tax rate before it was reduced after the Tax Cuts and Jobs Act.

Roughly 65 percent of plans contributed above the minimum requirement. The average contribution was about $19 million in 2017, while the average minimum required contribution was $3 million.

While sponsors are clearly motivated to fund their pensions as fully as possible to mitigate a decade of mounting PBGC premium exposure, October Three’s analysis shows many of those plans are not optimizing the timing and reporting of their contributions.

By maximizing so-called grace period contributions, which allow sponsors to record contributions that apply to a plan year after the year has passed, sponsors can increase the value of their plans and reduce their premium payments.

“In many cases, all or part of contributions made to satisfy quarterly contribution requirements could have been characterized as grace period contributions but weren’t. So, plans often report lower asset values than they could have – and, as a result, pay higher premiums than they need to,” October Three’s report says.

Under another best practice, year-end voluntary contributions can be accelerated, made by September 15, and recorded as contributions for the previous year.

Had plans accelerated their year-end contributions in 2017, total premium payments would have been reduced by $174 million, and $1.2 billion between 2010 and 2017.

The report acknowledges that accelerating a year-end contribution can be tricky—sponsors would have to know what cash is available. But the tactic can reduce premium payments by millions in the case of large contributions.

Hospitals, utilities show greatest lag in adopting best practices

Hundreds of plans analyzed by October Three are overpaying on their premiums, to the tune of $100 million annually, because they are failing to adopt recording and contribution timing best practices.

The most common costs come from simple recording errors by eligible plans that fail to make grace period contributions. “Lots of plans could have adopted best practices to reduce premiums by simply recording grace period contributions for the prior year, but failed to do so. We view these ‘recording errors’ as the most egregious failure to adopt best practices for premium management and the easiest to correct,” the report says.

“It’s simple—we’re just taking about recording numbers on a separate piece of paper,” explained Donohue, who said the error costs large plans an average of $500,000. “Large plans are less prone to best practice mistakes, but when they make them they tend to be costly.”

While more plans are clearly optimizing accounting practices, 24 percent of eligible plans continue to make recording errors, and over half could have reduced premiums by with the “modest” acceleration of contributions.

Errors are seen in all industries, but the hospital and utility industries are the largest culprits, according to October Three.

Hospital plans overpaid $5.4 million in premiums in 2017 due to simple recording errors—29 percent of recording errors throughout all industries were found in hospital plans.

Not counting the more complex year-end contribution scheduling, hospitals could have saved $8.1 million in premium payments by deploying simple acceleration strategies.

For utilities, $4.5 million was lost from recording errors. Utilities accounted for 25 percent of recording errors in all industries, even though the plans make up just 2 percent of the universe of all plans eligible to make grace period contributions.

One large utility paid $3.3 million in extra premium due to a recording error.

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