An important aspect of the pension preservation mission of the Pension Benefit Guaranty Corporation (PBGC) is its Early Warning Program (EWP) for single-employer defined benefit (DB) plans.
In an updated page on its website, PBGC says its experience under the EWP is that it can avoid terminating a plan by working with the plan sponsor to obtain protections before a business transaction significantly increases the risk of loss.
PBGC regularly monitors corporate transactions, events, or trends that could affect a plan sponsor’s ability to continue to support its DB plan. The agency internally identifies about 300 transactions, events, or trends each year that are potentially of concern and engages the plan sponsors to obtain additional information. It assesses the impact of these situations based on each employer’s financial and operational ability to support its pension promises. PBGC may follow this initial inquiry with a more in-depth review. Its engagement with these companies averages about 100 early warning cases each year.
Transactions, events, or trends that may be of concern include:
- A change in the group of companies legally responsible for supporting a pension plan (a controlled group), including a spin-off of a subsidiary – When a controlled group is split up, a plan may remain with or be transferred to a financially weaker sponsor or a sponsor made weaker by separation from the controlled group. A transfer of significantly underfunded pension liabilities related to the sale of a business. As in the case of a controlled group breakup, a plan may be left with or transferred to a weaker sponsor or controlled group.
- A major divestiture by an employer that retains significantly underfunded pension liabilities – Remaining business entities may not generate sufficient revenue to be able to afford the plan.
- A leveraged buyout involving the purchase of a company using a large amount of secured debt – The sponsor’s debt service requirements may make it difficult for the firm to afford to maintain its pension plan; risk of loss to participants and PBGC’s premium payers is then greater. In a leveraged buyout, this risk is magnified because the new debt is secured by company assets, which have priority over unsecured obligations such as pension funding obligations and PBGC’s claim for underfunding.
- A substitution of secured debt for a significant amount of unsecured debt – Lender requirements for secured debt may signal that the sponsor is facing challenges that could put plan funding at risk. Additionally, in the event of bankruptcy, secured debt reduces PBGC recoveries on claims for unpaid pension contributions and unfunded pension liabilities.
- The payment of a very large dividend to shareholders – A plan sponsor that uses its free cash flow or debt proceeds to pay substantial dividends or buy back its own stock may not leave itself with sufficient resources to fund its pension plan.
- Significant credit deterioration – Downgrading of a plan sponsor’s credit ratings could signal that the sponsor is, or is becoming, unable to support the plan.
- A downward trend in cash flow or other financial factors – Declining cash flow could signal that the sponsor is becoming unable to support the plan.