by Bob Collie, Chief Research Strategist, Russell Investments
When will the U.S. Pension Benefit Guaranty Corporation (PBGC) premiums force a change in contribution policy? A look at the federal agency’s accounting statements points to the answer: “Sooner rather than later.”
A Big Jump
The impact of recent premium increases is clear in the PBGC’s latest annual report, published last November. Commenting on it in a year-end review, Michael Moran of Goldman Sachs noted that while PBGC flat-rate premium income jumped by 12% in 2016, variable-rate premium (VRP) income leaped by 81%. Startling as that observation is, it perhaps does not do justice to just how big the increases are.
Let’s set the numbers into the longer-term context:
PBGC premiums famously started at $1 per participant following the passage of the Employee Retirement Income Security Act (ERISA) in 1974. Total premium revenue in 1980 was $71 million. That sum started to rise materially starting in 1986 following premium rate increases and the introduction of the variable-rate premium in 1988. By 1990, premium revenue had reached $659 million and it crossed the $1 billion threshold in 1996. It took until 2010 to pass $2 billion, and just 4 years more after that to pass $3 billion. Total premium revenue passed $4 billion in 2015 and topped $6 billion in 2016.
While the 2016 VRP number is an 81% increase from 2015, it is also a fivefold increase over 2011 and almost a 20-fold increase over 2008. This sharp increase in revenue reflects not only changes to the premium rate (from $9 per $1,000 of shortfall in 2008 to $30 by 2016) but also an increase in plan shortfalls, because plan funding overall was much stronger prior to the financial crisis.
The explosive growth in VRP revenue is probably not over: 2016’s $30 rate will be at least $42 by 2019, albeit with a perparticipant premium cap (currently $517), a cap that will presumably apply to an increasing number of plans.
Managing the Cost
What is revenue for the PBGC is, of course, an expense for the sponsors of pension plans.
Techniques to manage that expense include reducing plan headcount. That’s especially worthwhile in cases where the pension being paid is small and/or if the VRP premium cap applies.
And the cost of the VRP can be reduced by accelerating contributions to underfunded plans, so there’s a big incentive now to do that: The jumps in PBGC expenses are beginning to overcome plan sponsors’ reluctance to contribute more than the required minimum.
In this regard, it is notable that in an interview with The Wall Street Journal late last year, Fran Shammo, outgoing Chief Financial Officer (CFO) of Verizon Communications, explicitly identified PBGC premium increases as a consideration in pension-related decisions. It would have been hard to imagine such a comment from the CFO of a major corporation even 5 years ago.
In this context, recent announcements by a couple of major corporations (GM and Fedex) of billion-dollar-plus debt issuance to finance discretionary contributions to their pension plans should come as no surprise. It’s a clear sign that, for many plan sponsors, the minimum contribution policy has become unsustainable.
|Bob Collie is Chief Research Strategist, Americas Institutional, at Russell Investments.|