Tax Reform: Changes in PBGC Premiums Could Create a New ... · Tax Reform: Changes in PBGC Premiums...
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Third Quarter 2011 • The Key 7 Tax Reform: Changes in PBGC Premiums Could Create a New Outlook for Defined Benefit Plan Sponsors By: Jessica Skinner, J.D. The recent deficit reduction and tax reform debates in Washington have generated many major proposals that could drastically affect the retirement industry. Some of the most significant of these proposals will change Pension Benefit Guaranty Corporation (PBGC)’s premiums on defined benefit (DB) plans. These have garnered bipartisan support on the Hill; however, it is unclear how the increase will be applied and what vehicles will be used to assess premiums that come due. The only clarity regarding these proposals can be seen in the uncertainty they bring to the future of the defined benefit landscape. The increases have become a contention item among the business community and within retirement industry groups. This article will help you understand the background of the relationship between PBGC and DB employers, which proposal is causing the biggest uproar and arguments for and against these changes. Background When employers make DB pension promises to their employees, those benefits are insured (up to a statutory cap) by the PBGC. Employers are assessed premiums for that insurance. If the sponsor to the DB plan goes bankrupt, and the plan terminates, the PBGC will assume its assets and benefit obligations. If the plan lacks the assets to fund the benefits insured by the PBGC, the insurance fund takes a loss. The solvency of the fund thus depends on both the adequacy of the plan funding as well as the sufficiency of the PBGC premium assessments. Currently, funding requirements and premium assessments are established by federal law. Three Major Proposals Three significant proposals have surfaced affecting PBGC premiums as part of deficit reduction measures. The most contended of these is the proposal offered by President Obama and his constituents. President’s Budget: President’s Deficit Reduction/Tax Reform Proposal; Bowles/Simpson: Starting in 2014, the PBGC Board would set an increased level of PBGC premiums and take the plan sponsor’s credit risk into account in setting those premiums. Premium increases would be phased-in, and the budget would assume $16 billion in additional premiums within the next ten years. continued on page 8
Transcript of Tax Reform: Changes in PBGC Premiums Could Create a New ... · Tax Reform: Changes in PBGC Premiums...
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Tax Reform: Changes in PBGC Premiums Could Create a New Outlook for Defined Benefit Plan Sponsors
By: Jessica Skinner, J.D.
The recent deficit reduction and tax reform debates in Washington have generated many major proposals that could drastically affect the retirement industry. Some of the most significant of these proposals will change Pension Benefit Guaranty Corporation (PBGC)’s premiums on defined benefit (DB) plans. These have garnered bipartisan support on the Hill; however, it is unclear how the increase will be applied and what vehicles will be used to assess premiums that come due. The only clarity regarding these proposals can be seen in the uncertainty they bring to the future of the defined benefit landscape. The increases have become a contention item among the business community and within retirement industry groups. This article will help you understand the background of the relationship between PBGC and DB employers, which proposal is causing the biggest uproar and arguments for and against these changes.
Background
When employers make DB pension promises to their employees, those benefits are insured (up to a statutory cap) by the PBGC. Employers are assessed premiums for that insurance. If the sponsor to the DB plan goes bankrupt, and the plan terminates, the PBGC will assume its assets and benefit obligations. If the plan lacks the assets to fund the benefits insured by the PBGC, the insurance fund takes a loss. The solvency of the fund thus depends on both the adequacy of the plan funding as well as the sufficiency of the PBGC premium assessments. Currently, funding requirements and premium assessments are established by federal law.
Three Major Proposals
Three significant proposals have surfaced affecting PBGC premiums as part of deficit reduction measures. The most contended of these is the proposal offered by President Obama and his constituents.
President’s Budget: President’s Deficit Reduction/Tax Reform Proposal; Bowles/Simpson:Starting in 2014, the PBGC Board would set an increased level of PBGC premiums and take the plan sponsor’s credit risk into account in setting those premiums. Premium increases would be phased-in, and the budget would assume $16 billion in additional premiums within the next ten years.
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Domenici/Rivlin:Increase the fixed-rate premium by 15 percent (from $35 to about $40 per participant) and raise the variable-rate premium from $9 to $12 per $1,000 of underfunding. The estimated change would be an increase of about $5 billion over the course of nine years.
House (Ryan) Budget:The resolution does not specifically propose to increase PBGC premiums; however, a committee report that accompanies the resolution expresses concern about the PBGC’s financial situation and recommends reform.
The Heated Debate over the President’s Proposal
The most concerning of these three proposals, and the one that is garnering the most attention, is the proposal contained in President Obama’s deficit reduction plan. This proposal has the potential to make the offering of DB plans so unappealing for pension sponsors, many may cease to offer these benefits altogether. Essentially, it would give the PBGC increased authority to modify both the level and structure of premiums that pension sponsors are charged for pension insurance.
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Industry groups and affected plan sponsors are worried this proposal could further discourage an already administratively burdensome plan option; however, some contend the President’s proposal is the only way to strengthen the PBGC system and ensure it has adequate funding. Below are some of the most contentious arguments for and against the President’s proposal on the subject:
Arguments “For” the President’s Proposal
Arguments “Against” the President’s Proposal
If the structure and funding of the PBGC is not revised, the PBGC is in danger of a taxpayer bailout.
The PBGC’s annual report states: “Since our obligations are paid out over decades, we have more than sufficient funds to pay benefits for the foreseeable future.”
PBGC has a $23 billion deficit. The $23 billion deficit is based on very aggressive interest rate and other assumptions that it uses in the context of “distress” plan terminations and in its strategy to sue employers. PBGC’s annual report states that almost 30 percent of its deficit is solely attributable to the drop in interest rates within the last 12 months. Those historically low interest rates do not suggest any failure on the part of employers to responsibly fund pension plans, nor do those rates bear any resemblance to the likely interest rates that will prevail over the forthcoming decades. It makes no more sense to evaluate PBGC’s financial condition at a current single point in time, when interest rates are low and the stock market has not fully recovered, than it was to do so when interest rates were higher and the market was booming. It is the long-term outlook that is relevant, not a one-time snapshot into its financial status. Further, if an individual or a corporation purchases an insurance policy of any type, its premium is not based on the profit or loss of the insurance company in that year. Moreover, the premiums do not rise or fall based on the insurance company’s profitability as the policy is renewed each year. PBGC deserves a premium that reflects the risk it bears that an underfunded plan may terminate, and the agency will assume the plan’s obligations to pay benefits. This is the system that exists today with the variable rate premium, and it is the proper way to determine an agency’s risk.
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Arguments “For” the President’s Proposal
Arguments “Against” the President’s Proposal
The proposed premium increases are modest and would not have a material effect on businesses.
It appears premiums could, by the end of a phase-in period, increase annually by more than $1,000 per participant for some companies. This calculation is based on the following assumptions derived from the PBGC’s description of a likely way the premium increase would apply: (1) the entire additional premium increase could be imposed on plans maintained by employers that are below investment grade, (2) approximately 20 percent of plan sponsors are below investment grade, (3) the premium increase will be phased-in, so to raise the full $16 billion, the premium amount will be extremely high by the end of the phase-in period, and (4) the treatment of a plan sponsor as below investment grade will also be phased-in. Companies that have been below investment grade for many years will pay comparatively higher premiums, even though they will have maintained their pension plans throughout the period they have been below investment grade. This premium increase is by no means insignificant; and is particularly unjustified if the company’s plan is well-funded but the company has, for whatever reason, received a low credit rating.
Like any other insurance company, the PBGC should be allowed to determine the premium it charges its customers.
Unlike other insurance companies that can refuse to accept a prospective customer, the PBGC is required to provide termination insurance for all DB plan sponsors. However, the same is true for employers. A DB plan sponsor cannot shop around for another agency/insurer with whom to do business. By law, it must pay PBGC premiums. In this respect, the relationship is not like the private sector’s insurance marketplace from either the agency’s or the employer’s perspective. It is therefore fundamentally unfair to vest one party to this required relationship (i.e., PBGC) with the unilateral authority to decide the amount its customers (i.e., employers) must pay.
Moreover, even private-sector insurers must get approval from state insurance regulators for the premiums they charge. Why then, with the retirement security of millions of Americans dependent upon the willingness of employers to continue sponsoring DB plans, would Congress give an agency the power to set its own premiums?
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JESSICA SKINNER, J.D.Compliance AttorneyLockton Retirement Services816.960.9295 | [email protected]
Arguments “For” the President’s Proposal
Arguments “Against” the President’s Proposal
The government would not be involved in rating companies under the Administration’s proposal.
By necessity, the government would have to approve the actions of the private credit rating agencies; and by implication, the government would be rating private companies and tax exempt organizations. These credit ratings could have implications well beyond PBGC premiums, potentially affecting stock prices or the company’s ability to access credit sources.
The Outlook for DB Plan Sponsors:
It is obvious these changes could cause major concern for DB plan sponsors. It will likely have a lasting effect on the future of offering this plan option to employees, and could very well have inadvertent effects on companies that currently offer these options The Joint Special Committee on Deficit Reduction (the Supercommittee) is currently reviewing these proposals in its assignment to reduce the federal deficit. If you have questions or wish to contact your congressional delegation or those members serving on the Supercommittee, you are urged to contact your Lockton Retirement service team.
