Nobody really likes to pay insurance premiums, but they do appreciate the peace of mind that the coverage brings. For example, I may think that I won’t die in the next year and leave my family destitute, but I could. So I may be inclined to purchase life insurance to help my family and me sleep easier at night, knowing that, if something were to happen, they would have some financial assistance.

However, when it comes to pension insurance through the Pension Benefit Guaranty Corporation (PBGC), paying the premiums may not bring peace of mind to plan sponsors. The executive signing the check may believe the company’s financial position is solid, and there are assets set aside to back the benefit promise even if the plan is not fully funded. It may feel more like a tax than an insurance premium.

The pain of paying premiums has grown over the last several years as the PBGC premiums have increased, despite the PBGC’s funding deficit for corporate plans becoming a funding surplus. For single-employer plans in 2022, the flat-rate portion of the PBGC premium is $88 per participant, and the variable-rate portion is 4.8% of the pension plan’s unfunded PBGC liability (the premium funding target), subject to a per participant cap of $598. PBGC premiums have already become a significant expense for many plans, and these premium rates (including the 4.8% rate¹) are subject to future cost-of-living increases.

Plan sponsors wishing to reduce PBGC premiums have the three main tools listed below at their disposal. The tool that will most likely be helpful for a given plan depends on the plan’s funded status. A fourth tool, which may or may not be available will also be discussed.

Three options to reduce PBGC premiums:

1. Accelerate contributions: Particularly for moderately funded plans paying a variable-rate premium that is less than the cap.
2. Break up the plan: Best for (large) less well-funded plans paying capped PBGC premiums.
3. Count reductions: May work for other plans, but is the one option available for well-funded plans paying only flat-rate premiums.

To get a sense of where plans fall among these three different groups, we gathered IRS Form 5500 data for the defined benefit plans included in Milliman’s Corporate Pension Funding Study and Index, which looks at the 100 U.S. public companies sponsoring the largest defined benefit pension plans (many companies have more than one plan). We used this information to estimate PBGC liabilities and the related premiums. As can be seen in Figure 1, there was a decent spread between the three groups of plans. The most effective premium reduction strategy will depend on a plan’s funded status and the accompanying impact on the variable-rate premium status.  

Option one: Accelerate contributions

The 58 plans that are currently paying variable-rate premiums but are not at the cap can benefit from accelerated contributions. If a plan sponsor can contribute to the plan and cast it back to the prior plan year (contributions must be made within eight and a half months from the close of the prior plan year), the discounted value of any contributions will be treated for PBGC premium purposes as if they were in the plan at the beginning of the year. Every dollar contributed will reduce the plan’s unfunded PBGC liability, which will, in turn, lower the variable rate premium. Because the variable rate premium for 2022 is 4.8% of unfunded PBGC liability, the contribution effectively gives the plan sponsor a 4.8% return on their “investment,” until the contributions equal the unfunded PBGC liability.

The accelerated contributions could come from various sources:

1. For many plans, the American Rescue Plan Act of 2021 reduced the minimum required contribution. If the sponsor has a budgeted amount to contribute that exceeds the reduced minimum required contribution, then perhaps the excess could be contributed early and applied to the prior year.
2. If a plan sponsor has cash available, it may be possible to accelerate future contributions, including required quarterly contributions, and apply those contributions to a prior plan year. It may require some extra paperwork to create and then use credit balances to cover later required contributions, but the process is not overly burdensome.
3. If cash is not available, a plan sponsor may consider borrowing money to contribute into the pension plan. Prior to the recent run-up in interest rates, many companies could borrow money at rates less than the 4.8% rate for PBGC variable-rate premiums, meaning they could potentially save more money on PBGC premiums than what it would cost to finance the loan. With recent inflation, future PBGC rates may be much higher and could make this approach more attractive for some companies.

Option two: Break up the plan

The 87 plans paying PBGC variable-rate premiums subject to the cap have lower funding ratios than the other groups.

The option to accelerate contributions will, of course, improve the funded ratio of these less well-funded plans, but unless enough money is contributed, the contributions may not have an impact on the PBGC variable-rate premium. Based on the 2022 premium rates, the variable-rate premium cap comes into play when there is more than $12,458 in unfunded PBGC liability per participant ($12,458 x 4.8% = $598). As a result, making contributions will not reduce PBGC premiums until contributions are sufficient to reduce the unfunded PBGC liability to be less than $12,458 per participant.

A possibility for plans in this group may be to break up the plan with a spinoff of a particular group. For example, if the sponsor were to spin off the retirees into a new pension plan, it could possibly be done with enough money to eliminate the variable rate premiums for that group of participants. Thus, the plan sponsor will save $598 per year (perhaps over many years) for each spun-off participant. The funded percentage of the remaining group will be even worse than before but, because it is already at the PBGC variable-rate premium cap, the PBGC premiums will not be any greater as a result. This concept is illustrated in Figure 2.

The sponsor will have made one plan into two, which will now require two Form 5500 filings, two actuarial valuations, etc. The associated costs are more easily absorbed by larger plans. However, in the example in Figure 2, the PBGC premiums are reduced by almost $2.4 million per year. Some plans sponsors have decided the savings outweigh the new costs and have elected to push forward with this option, but it may not be right for every plan or plan sponsor.

Option three: Count reductions

The smallest group of the three consists of the 52 plans paying only flat-rate PBGC premiums. While other groups may also be able to benefit by reducing counts, it is the only option for these 52 plans. The reduction can be accomplished by either offering lump sums or purchasing annuities. Plan sponsors will eliminate the flat-rate premium for each participant removed, saving $88 per participant in 2022 and increasing savings in future years every year until they die due to premium indexing for inflation. Though not the focus here, reducing the plan size will also reduce the pension plan’s administration costs and related risks.

Many plan sponsors start by providing lump sums or purchasing annuities for the participants with smaller benefits. This approach eliminates those for whom the PBGC premiums are most significant, relative to the value of their benefits. Plan sponsors should also make sure that all nonelective lump sums (generally up to $5,000) are being paid.

Changing the interest rate basis

Another tool that may or may not be available or helpful for plans paying variable-rate premiums is to switch the interest rate basis for determining the PBGC liability. The PBGC allows two approaches to be used in determining the liability for premium purposes. The Standard Premium Funding Target uses segment interest rates that are current “spot” rates, while the Alternative Premium Funding Target is based on a 24-month average of the same segment interest rates. A plan sponsor must make a formal election to switch between the two sets of rates and, whenever an election is made, it must remain in place for five years.

When interest rates are rising, the Standard method typically provides more favorable interest rates (higher interest rates leading to lower liabilities), and the Alternative method is typically more favorable when rates are declining. However, because an election must remain in place for five years and future interest rates are never known with certainty, the choice that is optimal for the current year could be less favorable in upcoming years. While the ability to change these rates should not be ignored, a decision to change them should be made considering possible effects in future years and the potential impact of using one or more of the other tools mentioned above.

Summary

The PBGC premium reduction tool that best fits a given plan is likely to correspond to the type of PBGC premiums being paid for the plan, but each plan is unique. If you are interested in pursuing a premium reduction strategy for your plan(s), it would be best to partner with a retirement actuary to determine the best solution.

Bruce Mitton is a consulting actuary at Milliman. The above material represents the opinion of the author and is not necessarily the view of Milliman. Through publication of this article, we assume no duty of liability to any reader, each of whom is encouraged to seek the assistance of actuarial, investment, and legal advisors.

¹ At the time of this writing there is a proposal in the Senate to stop indexing the 4.8% rate, but the provision is not included in the House’s version of the legislation, so it may or may not be implemented.