Extended funding relief + higher PBGC premiums = a lethal combination
As funding relief is extended and PBGC premiums go up, plan sponsors may feel that it’s a case of good news/bad news. But when looked at in combination, it could be more a case of “heads you win, tails I lose.”
A tale of debt and relief
Let’s imagine you owe your parents $100,000 that you’ve agreed to pay back within the next 7 years. As a goodwill gesture, your father calls to tell you he is extending the payback period to 10 years and not to worry about paying anything the next few years. Great, you think, now you’ll have extra cash to spend before getting serious about paying your parents back. Before hanging up, though, your father mentions that there is a catch. It turns out that one of your brothers never paid back your parents on a loan a few years ago, so they think it’s best for them to set aside some extra funds to cover themselves in case another one of their indebted children goes broke.
“We think around 2-3% per year on the unpaid amount is fair for now, but the rate will go up – maybe to 5% in ten years,” your father says.
“Seriously?” you reply incredulously, “do you have any idea how much that is going to cost me?”
Your father sighs, “Well, that depends on how quickly you pay us back, but if you take a few years off and then pay what we’d agreed to after that, I’m guessing it would be at least $25,000.”
“So you’re telling me that to pay back a $100,000 loan I need to pay you over 25% on top of payments we’ve already agreed to, just so you can have a fund I probably won’t ever need?”
“Yeah, sorry about that, but keep in mind I am giving you a few extra years to pay us back.”
A good way for you to beef up that fund, you think. “Well, then can I get a refund once I’ve paid in full?”
Your father almost laughs, “No, no, it doesn’t work like that. Gotta run. Talk later.”
“But why do you need so much…” your father has hung up.
This is exactly what’s happening with the PBGC
As implausible as it may seem, recent legislative changes found in the Bipartisan Budget Act of 2015 can work out a lot like this scenario for DB plan sponsors. Underfunded plan sponsors are essentially in debt, and PPA is designed to require sponsors to pay back the debt in around 7 years. They also must pay into a system that covers failed plans, at a rate that until a few years ago did not garner much attention. Now that has changed.
Many view the extension of funding relief as a good thing since it gives companies more flexibility to fund their plan at their own pace. While this may seem attractive to sponsors, the ticking time bomb is the PBGC variable rate premiums. This premium penalizes underfunded plans, and unfortunately for sponsors the PBGC liabilities get no relief. The longer a company waits to fund up their plan, the more premiums the PBGC collects, to the point where as much as 25-30% of cumulative contributions are paid to cover PBGC premiums rather than to fund the plan (less so if the plan’s PBGC premium cap applies).
This jaw-dropping amount ought to give pause to plan sponsors resigned to paying just the minimum required contribution. There is now even more incentive for sponsors to fund up their plans earlier to avoid this cost, using either cash or by borrowing. The colossal rise in PBGC premium rates is detrimental enough, but when combined with a minimum funding policy based on extended funding relief, the results can be disastrous.