Why the latest PBGC premium increases may well speed the DB system to its death bed

The Bipartisan Budget Act of 2013 (BBA), announced on December 10, proposes significant increases in PBGC premiums for single-employer corporate pension plans. This could be seen as just one more blow among many to a beleaguered DB system.  But it may well be more than that.

The corporate defined benefit (DB) system is, of course, well past its youthful, growing phase. It has long since been overtaken by defined contribution in terms of total assets. It probably hit its peak liability value a year or so ago, so it’s a system that is already in widely-acknowledged decline. But when the obituary of the private sector DB pension system is finally written, history may well conclude that the political opportunism of BBA sped it to its death bed.

There are two reasons I say this. One: it is a big increase. It is a big increase that follows on from another big increase just one year ago, as part of MAP-21. The impact is significant: a plan with 2,000 members and a $10m funding shortfall would have paid $160,000 in 2012; that figure was due to rise to roughly $280,000 in 2015 under MAP-21’s revised schedule; under BBA, it’ll be $344,000 in 2015 and $408,000 in 2016.

Together, MAP-21 and BBA are going to make PBGC premiums one of the largest—possibly the largest—costs of running a DB plan. PBGC premiums will overtake investment management fees in many cases.

The concept of insurance via a government agency only really worked as long as the cost of insurance was small enough to be a marginal consideration in plan decisions. At the new levels, it’ll be anything but marginal. It will be a material consideration in a number of sponsor decisions.

With the per-participant premium rising to $64 in 2016, plan sponsors will have a significant incentive to shed participants through the payment of lump sums to terminated vested employees and annuity buyouts for retirees.

With the variable rate premium rising to 2.8% of shortfall by 2016, plan sponsors will have a significant incentive to fund up the plan: only corporations with an unusually high cost of capital will find it advantageous to delay contributions.

And, of course, when you add these together, there’s a big incentive for plan sponsors to revisit the question of whether they really want a DB plan at all.

The second reason I believe that this legislation will have a big impact is that it is blatantly political in nature. The PBGC—which reported a $27.4 billion shortfall in its single-employer program as of 30 September this year—is no doubt happy to receive this boost to its finances. But there’s no real doubt here that the motivation for the premium increase is the need to balance the government budget. If this were really about the PBGC, it would involve steps to buoy up the multiemployer program, which is in far worse shape than the single-employer program. So this legislation does not originate in a desire to protect plan participants or to ensure the robustness of plan funding or even to strengthen the PBGC. It treats the PBGC as a pawn in the political game. Plan sponsor resentment of the PBGC—which was already high—may become irreparable.

To strengthen this sense of political cynicism, it is far from obvious that PBGC premiums serve any purpose in actually balancing the budget at all: even though the Congressional Budget Office is counting the premiums as revenue, the PBGC is an independent government agency and there is no government guarantee of its funding position. I’m no expert on federal accounting practices, but PBGC assets do not seem to me to be government assets and PBGC liabilities do not seem to me to be government liabilities. The government does not control how the money raised is to be used; the premiums go into the PBGC coffers. So if anyone is able to explain exactly why PBGC premiums have been counted as revenue for the purposes of MAP-21 and now BBA, please let me know (and I will pass that explanation on to everybody else).

All of which will make the increase harder for plan sponsors to buy into. In short, this is a significant increase in cost, made less palatable by its political origins. That could prove to be an ugly combination.