Evaluating PBGC Premium Options in Advance of Big Increases

April 23, 2013 – 1:20 pm

Which door to choose?Each year, defined benefit (DB) pension plan sponsors must pay pension insurance premiums to the Pension Benefit Guaranty Corporation (PBGC). In light of large PBGC premium rate increases in 2013 and future years, plan sponsors should carefully evaluate their options before proceeding with their next premium payment.

Background

There are two components to annual PBGC premiums:

1. Flat rate premium based on the number of participants

2. Variable Rate Premium (VRP) based on the plan’s unfunded vested liabilities

As a result of last year’s Moving Ahead for Progress in the 21st Century Act (MAP-21), PBGC premium rates are scheduled to increase sharply over the upcoming years. Below is a table showing a summary of upcoming PBGC rate increases.

MPGC rate table 2013

Potential Strategies to Manage PBGC Premiums

Pension plan sponsors generally don’t like to pay PBGC premiums because it is money that could otherwise be spent on increased funding for the plan. With this in mind, here are some important issues to consider before proceeding with your next PBGC premium filing:

1. Unfunded liabilities for the VRP can be calculated using “standard” PBGC interest rates (snapshot rates) or “alternative” rates based on a 24 month average of the snapshot rates. Once you choose a method, you have to stick with it for at least 5 years. Since 2008 was the first year that plan sponsors could elect the “alternative” method, 2013 is the first year that they can make an election to switch back to the “standard” rates (though it likely won’t be advantageous to do so).

2. Over the long-term, both interest rate methods should produce similar VRP amounts even though the smoothed alternative interest rates will lag the standard rates. When interest rates are falling, VRPs based on the alternative interest rates should be lower than those using standard rates. The opposite will be true in a rising interest rate environment.

3. Sponsors of small pension plans (fewer than 100 participants) that haven’t completed their 2012 PBGC premium filing can actually lock-in beneficial VRPs for two years. Their 2012 premiums aren’t due until April 30, 2013 so they can estimate their 2012 and 2013 premiums under both the standard and alternative methods and see which one is the most economical.

4. Before switching interest rate methods just to get lower 2012 and/or 2013 VRPs, plan sponsors should be aware that it’s less expensive to be underfunded now than in 2014 or later years. That’s because the VRP premium rate is doubling in the next two years (see table above), which could wipe out any short-term VRP savings this year.

How could this strategy backfire? Consider a plan that switches to the alternative VRP method in 2013 in order to lower their unfunded liability by $1M. This would decrease their 2013 VRP by $9K (i.e., $9 per $1,000 in unfunded liability).

Now suppose that interest rates increase before 2014. The standard interest rate method would immediately use those higher interest rates to calculate 2014 VRPs. The alternative rates would lag and be lower than the standard rates, which would produce higher unfunded liabilities. Let’s suppose that the alternative method 2014 unfunded liability is now $1M higher than using the standard method. This means that the alternative method 2014 VRP would be $12K higher (i.e., $12 per $1,000 unfunded liability since the VRP rate increases in 2014) and you end up with a net loss of $3K on VRP for the two plan years.

Next Steps

What’s a plan sponsor to do? The 5-year commitment to the “standard” or “alternative” interest rate method means you can’t guarantee lower PBGC VRPs using one or the other. However, you should evaluate your options each year. If cash is tight and interest rates are on the move, it may be worth choosing one method or the other for some short-term PBGC premium savings with the knowledge that doing so could expose you to higher premium rates in upcoming years.

By Mark Schulte | Posted in Cash balance plans, Defined benefit plans, PBGC, Private pensions | Tagged , , , , , , , , , | Comments (1)

Déjà Vu All Over Again: PBGC Extends Reportable Event Relief for 2013 and Beyond

January 30, 2013 – 4:54 pm

PBGC logoIn what has become an annual rite of winter, the PBGC recently released PBGC Technical Update 13-1 extending relief from the proposed amendments to the reportable events regulations for certain small pension plans. However, unlike previous years’ relief, the new technical update provides guidance for all plan years after 2012 (or until new proposed or final rules are released) and not just a one-year extension.

Summary of Important Guidance

Similar to the prior pronouncements, the new Technical Update:

– Extends the waiver of the requirement to report a missed quarterly contribution for small pension plans under ERISA §4043.25. This waiver is valid as long as the plan (1) has fewer than 25 participants or (2) has between 25 and 100 participants and files a simplified notice with the PBGC. In both cases, the reason for the missed quarterly contribution cannot be due to financial inability.

– Affirms that the assets and liabilities used to calculate the PBGC variable rate premium should be used to determine reporting requirements for events occurring during the following plan year. This includes determining whether the plan is eligible for reporting waivers, reporting extensions, or is subject to advance reporting requirements.

Of course, the relief in Technical Update 13-1 will be superseded once the PBGC issues  final rules.

After four years of temporary reportable event relief, it seems likely that the new proposed regulations will eventually incorporate some of this relief on a permanent basis. At the very least, Technical Update 13-1 provides the stability of knowing that reportable event relief will continue until new rules are released and that we won’t have to wait for the PBGC to reaffirm the relief annually.

By Mark Schulte | Posted in Cash balance plans, Defined benefit plans, PBGC, Private pensions | Tagged , , , , , | Comments (0)

OPEB Investments – The Danger of Playing It Safe

January 25, 2013 – 4:19 pm

CautionUnder GASB 43 and 45, public sector employers are required to account for retiree medical benefits under special rules for Other Post-Employment Benefits (OPEB).  Many have chosen to pre-fund these liabilities in a trust similar to a retirement plan trust.  At the recent Minnesota School Board Association convention, Van Iwaarden Associates teamed up with an investment advisor to emphasize how actuaries and investment advisors should work together to develop a prudent investment policy based on projected benefit payments.

Most policy makers at public sector employers are not investment experts nor are they experienced with pre-funding long term liabilities.  Too often, the decision is made to invest trust assets in “safe” investments just as they do with operating funds.  This is potentially a major mistake, especially now with short term interest rates near zero!

The best practice is to pre-fund retiree medical liabilities and to invest the trust assets in a way that is consistent with the projected cash flow.  Certainly, a substantial portion of the assets should be invested for the short term to meet short term cash flow.  However, the balance of the assets should be invested for the long term to meet projected cash flows twenty to thirty years away.

The recommended action plan for decision makers includes:

1.    Estimate the projected life of the OPEB Trust
2.    Review investment policy and its handling of OPEB
3.    Amend policy and investment strategy appropriately

A detailed actuarial report is the start of the process to manage OPEB liabilities and assets.  The actuarial report can and should be much more than just a perfunctory exercise to meet GASB accounting requirements.
The full presentation can be found through this link.

By Mark D. Meyer, JD, FSA | Posted in GASB 45, Investments, Other post-employment benefits (OPEB), Public plans | Tagged , , , , | Comments (0)

Expect Lower Discount Rates (and Higher Liabilities) for 2012 Pension Disclosures

January 16, 2013 – 2:28 pm

Pension discount rates continued to drop during 2012 and plan sponsors should prepare for yet another potential upward spike in balance sheet liabilities for the fiscal year ended December 31, 2012.

Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates may decrease by roughly 35 basis points. This could present yet another increase in the pension liability compared to FY2011 (when many thought rates couldn’t get any lower). Fortunately, many plans also experienced strong investment returns during 2012 so the combined effect on the net balance sheet liability may be muted.

Analysis

In the chart below we compare the CPDC over the past four years at different dates (12/31/2009, 12/31/2010, 12/31/2011, and 12/31/2012). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the discount rate produced by the curve for an average pension plan.

Citigroup comparison 12312012

Rates on the long end of the spectrum dropped slightly since 12/31/2011, while short and medium-term rates had a more pronounced decrease. This means plans whose liabilities are “front-loaded” (i.e., significant portion of benefits expected to be paid in the next 15 years) will see larger liability increases. Examples are plans with high concentrations of retirees or those that have been frozen or closed to new entrants for many years.

Net Effect on Balance Sheet Liability

If asset performance was strong during 2012, then this will moderate the situation since the net shortfall (assets minus liabilities) is reported as the balance sheet liability.

Below is a simplified illustration for a plan that was 80% funded on 12/31/2011 and we assume a 5% increase in pension liability during 2012. We then compare the funded status results under two asset scenarios: (1) Level assets since 12/31/2011 and (2) Assets 5% higher than 12/31/2011.

Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported balance sheet liability.

12312012 bal sheet liability example

Conclusions

So, what’s a plan sponsor to do when faced with a big increase in pension accounting liability? Here are a few ideas.

  • Your plan’s specific cash flows could have an enormous impact on how much the drop in fixed income rates affects the pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC to see how it stacks up.
  • Additional plan funding (above the IRS minimum requirements) may be appealing in 2013. Not only will it increase the plan’s funded status, but it will also help lower your pension plan’s PBGC variable rate premiums.
  • If you’ve implemented an LDI strategy for a portion of the pension trust portfolio, then the drop in discount rates should be accompanied by a corresponding increase in your asset value. If you haven’t adopted an LDI investment strategy yet, now may be a good time to revisit this policy.
  • There are some alternatives to the CPDC and CPLI as a basis for setting accounting discount rates, such as “above-median” versions of these rates. Check with you actuary or auditor to see what your options are.
By Mark Schulte | Posted in Defined benefit plans, Investments, LDI, Private pensions | Tagged , , , , | Comments (0)

What’s the Impact of 2013 IRS Retirement Plan Limits?

October 18, 2012 – 1:43 pm

The IRS just announced the 2013 retirement plan benefit limits and we’re seeing some modest increases from 2012. What does it all mean for employer-sponsored retirement plans? This post analyzes the practical effects for both defined contribution (DC) and defined benefit (DB) plans, followed by a table summarizing the limit changes.

Changes affecting both DB and DC plans

  • Qualified compensation limit increases from $250,000 to $255,000. Highly-paid participants will now have more of their compensation “counted” towards qualified plan benefits and less towards non-qualified plans. This helps for both nondiscrimination testing as well as for benefits.
  • HCE compensation threshold remains at $115,000. For calendar year plans, this will first affect 2014 HCE designations because $115,000 will be the threshold for the 2013 “lookback” year. When the HCE compensation threshold doesn’t increase and keep pace with employee salary increases, employers may find that more of their well-paid employees become classified as HCEs. Eventually, this could have two direct outcomes:
  • Plans may see marginally worse nondiscrimination testing results (including ADP results) if there are more HCEs. It could potentially make a big difference for smaller plans that were very close to failing the tests.
  • More HCEs means that there are more participants who must receive 401(k) deferral refunds if the plan fails the ADP test.

DC-specific increases and their significance

  • Increase in annual DC 415 limit from $50,000 to $51,000 and 401(k) deferral limit from $17,000 to $17,500. A $1,000 increase to the overall DC limit and $500 increase to the deferral limit isn’t much, but it will allow participants to get a little more “bang” out of their DC plan. Since the 401(k) deferral limit counts towards the total DC limit, this means that an individual could potentially get up to $33,500 from profit sharing ($51K – $17.5K) if they maximize their DC plan deductions. Previously, their profit sharing limit would have been $33,000 ($50K – $17K)
By Mark Schulte | Posted in 401(k) plan, Cash balance plans, Defined benefit plans, Defined contribution plans, Private pensions, profit sharing plan, Public pensions | Tagged , , , , , , , , | Comments (0)

MAP-21: Good News & Bad News for Pension Plans

July 12, 2012 – 1:51 pm

The “Moving Ahead for Progress in the 21st Century” (MAP-21) legislation signed into law last week included significant pension law changes.  These included good news and bad news for sponsors of defined benefit pension plans.

The good news is that MAP-21 provided some relief from the historical low interest rate environment.  The funding segment interest rates (which are based on 24 month average rates) will now be restricted to a range around the 25 year average rates.  That range is 10% for 2012, ramping up to 30% for 2016 and beyond.  This effectively increases the funding interest rates for 2012, which can significantly lower the liability and minimum contribution requirements from what they otherwise would be.

The bad news of MAP-21 is sharp increases in PBGC premium rates.  The fixed and variable rate premiums will increase as shown in the table below.  Rates will also be indexed for inflation.

Certain plans will also need to disclose the effect of the stabilized interest rates to participants on the Annual Funding Notice.  This applies to plans with 50 our more participants, a funding shortfall of $500,000 or more (based on rates without stabilization), and stabilized Funding Target less than 95% of the Funding Target without stabilization.

It’s important to note that the interest rate changes are optional for 2012.  Some plans, like professional firm cash balance plans, will not benefit from the interest rate changes and can avoid the expense of restating their 2012 valuation results.

Many plans will want to take advantage of the option to calculate the minimum contributions with the stabilized rates.  Those that do will have the option to measure funded status for benefit restriction purposes with or without stabilization.  MAP-21 does not allow the stabilized rates to be used for 2012 benefit restrictions without also using them for the minimum contribution calculation.

The interest rate stabilization of MAP-21 will not apply to the minimum lump sums under §417, maximum deductible contributions, PBGC variable rate premiums or PBGC §4010 reporting.  Pension accounting under FASB ASC 715 is also not affected.

Additional guidance from the IRS is needed to determine the exact impact of this law change and how to implement it for 2012.  Please contact Van Iwaarden Associates if you would like an estimate of the impact on your plan or to discuss the application of these rules in more detail.

By Peter Cullen | Posted in Cash balance plans, Defined benefit plans, PBGC, Private pensions | Tagged , , , , | Comments (1)

Low Pension Discount Rates = Big Accounting Liabilities for FY2011

January 5, 2012 – 11:08 am

Pension discount rates have plummeted over the past few months and plan sponsors should prepare for a potential upward spike in balance sheet liabilities for the fiscal year ended December 31, 2011.

Using the Citigroup Pension Discount Curve (CPDC) as a proxy, pension accounting discount rates could decrease by 100 basis points (or more). This will mean a big increase in the pension liability and net balance sheet liability for many plans.

Analysis

In the chart below we compare the CPDC over the past two years at different dates (12/31/2009, 12/31/2010, 6/30/2011, and 12/31/2011). We also highlight the Citigroup Pension Liability Index rate (CPLI) at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.On the short end of the spectrum, rates continued to drop between FYE2009 and FYE2011. The bigger issue may be the dramatic drop in rates on the long end of the spectrum (e.g., years 15 and beyond) since 6/30/2011.

A large portion of many pension plans’ obligations are discounted at these long-term rates, so they could have a significant impact on the accounting liabilities. This is particularly true for retiree medical plans where assumed health inflation means that considerably higher costs are projected in the later years.

Net Effect on Balance Sheet Liability

If asset performance was weak during 2011, then this will exacerbate the situation since the net shortfall (assets minus liabilities) is reported as the balance sheet liability.

Below is a simplified illustration for a plan that was 90% funded on 12/31/2010 and we assume a 10% increase in pension liability during 2011. We then compare the funded status results under two asset scenarios: (1) Level assets since 12/31/2010 and (2) Assets 5% lower than 12/31/2010.

Depending on the starting funded status, the change in pension liabilities and assets can have a dramatic leveraging effect on the reported balance sheet liability.

Conclusions

So, what’s a plan sponsor to do when faced with a big increase in pension accounting liability? Here are a few ideas.

  • Your plan’s specific cash flows could have an enormous impact on how much the drop in fixed income rates affects the pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC to see how it stacks up.
  • If you’ve implemented an LDI strategy for a portion of the pension trust portfolio, then the drop in discount rates should be accompanied by a corresponding increase in your asset value. If you haven’t adopted an LDI investment strategy yet, now may be a good time to revisit this policy.
  • There are lots of alternatives to the CPDC and CPLI as a basis for setting accounting discount rates. Check with you actuary or auditor to see what your options are.
By Mark Schulte | Posted in Defined benefit plans, Investments, LDI, Private pensions | Tagged , , , , | Comments (0)

Déjà vu: PBGC Extends Reportable Event Relief for 2012

December 12, 2011 – 8:48 am

Almost a year to the day after providing relief for the 2011 plan year, the PBGC released PBGC Technical Update 11-1. This notice provides guidance for the 2012 plan year on how to comply with the proposed amendments to the reportable events regulations.

Summary of Important Guidance

Similar to the prior pronouncements, the new Technical Update:

– Extends the waiver of the requirement to report a missed quarterly contribution for small pension plans under ERISA §4043.25. This waiver is valid as long as the plan (1) has fewer than 25 participants or (2) has between 25 and 100 participants and files a simplified notice with the PBGC. In both cases, the reason for the missed quarterly contribution cannot be due to financial inability.

– Affirms that the assets and liabilities used to calculate the 2011 PBGC variable rate premium should be used to determine reporting requirements for events occurring during the 2012 plan year. This includes determining whether the plan is eligible for reporting waivers, reporting extensions, or is subject to advance reporting requirements.

Technical Update 11-1 also mentions two other small PBGC-related items:

  • It acknowledges that the reaction to the proposed 2009 reportable event regulations has been largely negative. So, the PBGC will issue new proposed regulations that “will more effectively target troubled plans and sponsors while reducing burden for those that are financially sound.”
  • If the PBGC issues a final rule before the end of 2012, then the guidance in Technical Update 11-1 will be superseded by the final rules.

After three years of temporary reportable event relief, it seems likely that the new proposed regulations will incorporate some of this relief on a permanent basis. We’ll just have to wait and see whether the rules are formalized in 2012 or whether we get another extension as an early Christmas present next year.

By Mark Schulte | Posted in Cash balance plans, Defined benefit plans, Private pensions | Tagged , , , , | Comments (0)

Steering Clear of Pension Benefit Restrictions

November 25, 2011 – 11:44 am

Negative asset performance and declining valuation interest rates during 2011 will cause some pension plans to face benefit restriction issues for the first time in 2012.   Potential repercussions include limits on accelerated distributions (lump sums), restrictions on plan amendments increasing the value of benefits, mandatory benefit accrual freezes and restrictions on unpredictable contingent event benefits (UCEBs).

Many sponsors want to do all that they can to avoid these benefit restrictions.   Regulations allow four options to do so:

  1. Waiving credit balance – If there is any credit balance (carryover balance or prefunding balance) on the valuation date, the easiest way to improve the funding status is to waive the balance.  In fact, this action is required in certain cases.  The trouble is, for most underfunded plans, the credit balance is not big enough to be of much help.  It can also reduce future funding flexibility.
  2. Posting security – Sponsors can also post funds in escrow outside of the plan and count it as an asset for purposes of determining if benefit restrictions apply.  This option comes with plenty of strings attached, and would not truly improve the funding status of the plan.
  3. Additional current year contribution – A third option is to make an additional contribution for the current year (a “436 contribution”).  A 436 contribution needs to be made before the date the restriction would otherwise start.  This option can avoid restrictions on UCEBs, amendments and accruals, but not limits on lump sums.
  4. Additional prior year contribution - The fourth and perhaps most attractive option is to make an additional contribution for the prior year.  Here are a few things plan sponsors considering this solution should know:
    • The contribution does not need to be made before the valuation date.  For example, a plan sponsor that is concerned their January 1, 2012 funded status may trigger benefit restrictions would not need to make an additional contribution by December 31, 2011.  This is important because it allows time for the plan’s actuary to measure the preliminary funded status, determine if a contribution is needed to avoid restrictions, and to calculate the amount of such a contribution.
    • The January 1, 2012 funded status generally needs to be certified by March 31, 2012.  Ideally, additional contributions would be made by this date because the actuary can not certify the status based on contributions that haven’t already been made.  However, an actuary can issue a “range certification”.  For example, the actuary can certify that once the contribution is made, the funded status will be between 80% and 100%.  This prevents restrictions and allows the sponsor to have until the normal contribution due date (the earlier of September 15, 2012 and the date the 2011 tax return is filed) to fund any additional contribution for 2011.
    • The contribution increase may be more affordable than it first appears.  That’s because any additional contribution for the prior plan year is included in the assets for determining the minimum contribution on the next valuation date.   Making an additional 2011 contribution of $1,000,000 may reduce the 2012 minimum contribution by about $160,000.
    • WARNING:  If, for any reason, the additional contribution isn’t made so the final funded status is outside of the previously certified range, there are serious consequences.  Potential consequences include retroactive benefit restrictions and plan disqualification.  Therefore, the sponsor needs to be absolutely sure that they will be able to make the contribution prior to requesting a range certification.

Since benefit restrictions can be complicated and costly to implement, it makes sense to avoid them – especially if they can be avoided by paying down unfunded liability that needs to be funded sooner or later.

By Peter Cullen | Posted in Cash balance plans, Defined benefit plans, Private pensions | Tagged , , , , , | Comments (0)

Employers Need to Understand Minimum Profit Sharing Benefits for Frozen/Terminated DB plans

November 9, 2011 – 8:44 am

Freezing or terminating a defined benefit (DB) pension plan can have unforeseen implications for a company’s profit sharing plan. This is especially true if the plans are top-heavy or rely on IRS cross-testing methods (e.g., professional firm cash balance plans). This post explores changes to minimum profit sharing benefits that occur when plan sponsors freeze or terminate their top-heavy/cross-tested DB plan.

Background

When retirement plans are top-heavy and/or rely on cross-testing procedures to pass IRS nondiscrimination testing, there are several minimum benefits that must be provided to non-Key employees and non-highly compensated employees (NHCEs). For sponsors of both a DB and a DC plan, these minimum benefits often include:

  • 5% DB/DC top-heavy minimum for all participants employed at year-end or who work at least 1,000 hours during the year (note: separate DB and DC options are available instead of the single 5% minimum)
  • 7.5% DB/DC minimum “gateway” allocation for cross-testing

What happens when the DB plan is frozen or terminated?

When accruals in the DB plan cease, there are a couple of immediate consequences for the minimum profit sharing allocations. Read More »

By Mark Schulte | Posted in 401(k) plan, Cash balance plans, Defined benefit plans, Defined contribution plans, Private pensions, profit sharing plan | Tagged , , , , , , , | Comments (0)
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