PBGC Methods: Think Before You Switch

by | Aug 22, 2019 | bytesize, Defined Benefit

Pension plan sponsors have less than eight weeks to re-visit a 2019 cost-reduction decision that could end up coming back to bite them in 2020.

PBGC premiums for 2019 are coming due soon, and there are two options to determine the interest rate used when calculating a plan’s premium based on underfunding. One option will reduce the premium this year, but at the likely cost of a higher premium next year.

Interest rates rose in 2018. With higher interest rates, the “Standard Method” for calculating the PBGC variable rate premium (“VRP”) generally results in a lower premium than using the “Alternative Method”. Thus, for 2019 calendar year plans, the “Standard Method” is generally preferable. But due to the drastically falling rates in 2019, particularly in August, the “Alternative Method” appears as if it will be much better for 2020 calendar year plans.

Unfortunately for sponsors, an election to change from one method to the other is “locked in” for 5 years; once you switch methods, you cannot change back until at least 5 years after the change. In light of the recent, dramatic change in the interest rate environment, plan sponsors who were planning to switch to the “Standard Method” based on where interest rates stood early in 2019 may want to re-examine what the VRP may look like in 2020 if they make such an election.

The difference in the interest rates used by the 2 methods at 1/1/19 was about 30 basis points. Right now, it appears that the interest rate difference in 2020 might be 70 basis points. So any savings you get from the “Standard Method” in 2019 might be less than half of the extra amount that you’ll pay in 2020. You may save a million dollars in October 2019, only to have to pay more than $2 million in October 2020. It may be worth paying a little more this year to insure you can survive next year’s premium payment, and to avoid “locking in” to a method that may end up hurting more than it helps.

Each situation differs. There will certainly be plans that will be fully funded, or that may be reaching the VRP maximum cap, or for which 2019 will be the final year the PBGC VRP will be due. Some plans may be fully hedged against interest rate risk, such that the “Standard Method” proves to be a less volatile fit. These situations will change the analysis as to which method will be best. Ask your actuary – or better yet, ask one of ours!

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