Brad Smith, a partner in NEPC’s corporate services practice, says Pension Benefit Guaranty Corporation (PBGC) premiums are very quickly approaching the breaking point for many plan sponsors.
In fact, according to brand new poll results shared with PLANSPONSOR, fully two-thirds of sponsors say they are now having to plan changes to their defined benefit (DB) programs in the wake of the Bipartisan Budget Act of 2015. The major spending accord touches on employer-sponsored retirement plans in a few ways, Smith notes, “some good and others not so good.”
“When the Bipartisan Budget Act of 2015 was signed into law last November, it was a bit of good news and a bit of bad news for our industry,” Smith explains. “The good news was that the Act extended pensions stabilization rules for three more years—which for a lot of plans will mean three more years of potential contribution holidays. But it also pretty significantly jacked up Pension Benefit Guaranty Corporation fixed- and variable-rate premiums. This was after a lot of plan sponsors probably thought they had seen the last rate hike for the foreseeable future.”
And it’s not a modest rate hike that was programmed into the Bipartisan Budget Act, Smith continues. The flat-rate premium for PBGC insurance coverage of a pension funding shortfall is going up by another 25% over the next three years, while the variable rate will be up closer to 35%. This means annual fixed-rates in 2019 will rise to $80 per participant, while the variable rate will rise to 4.1% on unfunded vested benefits.
“As we started to meet with our clients after the Act was signed in November, we were constantly being asked, what is everyone else doing because of this?” Smith explains. “That’s what led to the new polling. Looking through the numbers it bears out a lot of what one would expect.”
NEXT: What clients are planning
According to the internal NEPC polling, there is a pretty big number (34%) of pension plan sponsors that say they have nothing planned in response to the latest rate hike announcement, but Smith “expects that number to reduce dramatically the further we get into 2016 and 2017.”
“The premiums are just getting too high for many DBs to feel comfortable paying them,” Smith says. “As the year rolls along and plan sponsors have to start cutting these checks, the pain and concern will only increase.”
Of the 66% of respondents who are changing their DB plans, about a third (32%) are considering higher contributions, while the same number (32%) are considering lump sum payouts. About one in five (17%) are considering partial pension risk transfer in the form of annuities.
“It’s about 50-50 for plan sponsors that say they’ll take action, whether they will pull one lever versus pulling two or more levers to get on top of the upcoming rate hikes,” Smith adds. “We’re seeing plans in the mid-market, say the $300 million to $1 billion zone, being more active and looking to pull more levers than the larger plans.”
Thinking about the NEPC client base, this makes sense, Smith concludes. “If you have a $5 billion or $10 billion pension portfolio, to close a 10% or 15% funding gap will take a pretty big pot of money. A smaller pension plan run by an organization in a higher cash-flow industry would have a much easier time finding the 10% or 15% needed to close the gap in one go. We expect to see a lot of this activity in the next several years, without a doubt.”