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- How are premiums set and why have they recently changed?
- What interest rate is used to determine variable-rate premiums?
Q: How are premiums set and why have they recently changed?
A: PBGC has three sources of premium income—a flat-rate premium, a variable-rate premium, and a termination premium. The rates for all three are set by law.
Flat-Rate Premium
The flat-rate premium is a per-participant premium that plans pay to PBGC each year. From 1991 through 2005, Congress set the flat premium rates at $19.00 per participant for insured single-employer plans and $2.60 per participant for insured multiemployer plans. The Deficit Reduction Act of 2005 (DRA) increased the single-employer rate for 2006 to $30.00 per participant and the multiemployer rate to $8.00 per participant. It further provided that, thenceforth, these rates would be indexed to increases in the average national wage, as determined by the Social Security Administration, and then rounded to the nearest whole dollar. In 2008, the rate for the flat premium is $33.00 per participant in insured single-employer plans, while that for multiemployer plans is $9.00 per participant.
Should the average national wage index fall in the future, the flat premium rate would not be reduced, but would remain at its then-current level until the national average wage increased sufficiently to warrant a further increase in flat premium rates.
Variable-Rate Premium
The variable-rate premium applies only to insured single-employer plans that have unfunded vested benefits. The rate for the variable-rate premium is $9 per $1,000 of underfunding. This rate has been in effect since 1991 and is not scheduled to change in the future. The Pension Protection Act of 2006 (PPA) made several changes that affect the amount of variable-rate premium underfunded plans will pay. Effective beginning with the 2007 plan year, PPA imposed a cap on the variable-rate premium for plans of small employers. If all contributing sponsors to the plan and their controlled group members have 25 or fewer employees, the per-participant variable-rate premium for that plan will be capped at $5.00 times the number of participants in the plan. (The cap for the plan as a whole is effectively $5.00 times the square of the number of plan participants.) Effective beginning with the 2008 plan year, PPA (1) removed an exemption that allowed some underfunded plans to escape payment of the variable-rate premium and (2) modified how underfunding is determined for variable-rate premium purposes.
Termination Premium
The DRA introduced and PPA modified a new premium that some sponsors of terminating plans will be required to pay to the PBGC. This new "termination premium" applies to certain distress and involuntary pension plan terminations that occur after 2005. For most affected plans, the annual termination premium is $1,250 per participant. For certain airline-related plans that terminate within five years of electing to be covered under special funding rules, the annual termination premium is $2,500 per participant. The termination premium must be paid to PBGC annually for three years after the plan terminates.
Q: What interest rate is used to determine variable-rate premiums?
A: Variable-rate premiums are equal to $9 for every $1,000 of underfunding. For this purpose, the statute provides rules for how assets and liabilities (and thus, underfunding) are determined.
The liability portion of the calculation is equal to the present value of vested benefits expected to be paid in the future. In order to determine the present value, benefits expected to be paid in the future must be discounted to reflect the interest that will be earned between the measurement date and the expected payment date. The applicable discount rate is mandated by law.
2008 and later
For plan years beginning in 2008 or later, the mandated discount rate is based on corporate bond yields. Rather than having one rate apply for the entire discounting period, the rate varies based on the length of the discount period. For example, benefits expected to be paid in the next few years will be discounted based on yields on short-term bonds. Benefits that are not expected to be paid until 20-30 years in the future will be discounted based on yields for long-term bonds. Under the new premium rules, present value is generally determined using three interest rates (“spot segment rates”), each of which applies to cash flows during specified periods. Information on the spot segment rates appears on the PBGC Web site. The new premium rules also permit the use of alternative discount rates.
Years before 2008
Before 2008, instead of a yield curve approach, a single rate was used to discount future benefit payments, no matter how far into the future those benefits were expected to be paid. The interest rate basis changed throughout the years. Originally it was tied to 30-year Treasury rates. Starting in 2004, it was tied to yield on corporate bonds.
For a complete history of interest rates used to determine variable-rate premium, see http://www.pbgc.gov/practitioners/interest-rates/content/hr1127.html
