(December 16, 2013) — The new budget agreement including an increase in Pension Benefit Guaranty Corporation (PBGC) premiums is expected to help reduce funded ratio volatility and raise revenue, accord to Aon Hewitt.
The bipartisan budget act is projected to influence pensions’ risk management strategies—particularly by “creating a stronger link between contribution strategy and investment strategy.”
According to Aon Hewitt’s report, the rise in PBGC premiums will incentivize plan sponsors to settle more liabilities through lump sums and annuity purchases as well as encourage contributions above the minimum.
“In 2016 [and onwards], discretionary contributions for underfunded plans will have at least a 2.9% ‘alpha’ due to avoiding PBGC premiums,” the report said.
And most of all, these changes would create an “asymmetric” risk/reward tradeoff for fully funded plans to help reduce funded ratio volatility—PBGC premiums can increase in “pessimistic scenarios,” but cannot decrease in “optimistic scenarios.”
“The level of PBGC variable premiums depends on how underfunded a plan gets and how long it stays underfunded,” Aon Hewitt said. “This disincentivizes high-risk/high-reward investment strategies for well funded plans.”
The consulting firm concluded that if the proposed PBGC premiums increases are enacted into law, they would encourage plan sponsors to “aggressively fund their pension plans” and pursue greater de-risking strategies such as pre-funding.
The proposal asked for a rise in carrying costs for unfunded liabilities—expected to exceed up to 3% beginning in 2016—allowing plan sponsors to explore options of pre-funding to avoid said costs.
Plan sponsors, however, may have the opportunity to add a “time dimension” to their investment strategies, Aon Hewitt said, as the legislation is phased over a few years.
Related content: PBGC vs. PPF: Let’s Get Ready to Rumble (Part One), PBGC vs. PPF: Let’s Get Ready to Rumble (Part Two)