As we noted in a post last year at this time, pension plans that are not fully funded for PBGC purposes have two parts to their PBGC premium. One part is a flat rate premium of $83 per participant in 2020 ($86 for 2021, as just announced by the PBGC). The other is a variable rate premium that looks to the value of the plan’s “unfunded vested benefits,” which is the excess, if any, of the plan’s Premium Funding Target over the fair market value of plan assets.
The Premium Funding Target is generally determined the same way as the plan’s funding target for ERISA Section 303 minimum funding requirements, with one important exception. The interest rate used to measure the Premium Funding Target is a “spot” rate, rather than an interest rate averaged over 24 months. In lieu of using the special premium discount rates, a plan sponsor may make an election (irrevocable for five years) to use smoothed discount rates, similar to, and in some cases identical to, the rates used to determine the minimum required contribution (the Alternative Premium Funding Target). The PBGC variable rate premium for 2020 is 4.5% of the plan’s unfunded vested benefits, subject to a headcount cap of $561 per participant (increasing in 2021 to 4.6% of the plan’s unfunded vested benefits, with a headcount cap of $582 per participant).
With the decline in interest rates thus far in 2020, plans may expect a further increase in their variable rate PBGC premium for 2021 because the value of the “unfunded vested benefits” may be quite a bit higher in 2021 compared to 2020. In this regard, each of the spot segment rates in December 2019, used for determining variable rate premiums for 2020 for calendar year plans, is substantially higher than the comparable spot segment rates in September 2020. The spot segment rates in December 2020 will be used to determine variable rate premiums in 2021 for calendar year plans unless the Alternative Premium Funding Target has been elected.
We recommend that plan sponsors check with their actuaries to determine estimated total PBGC premiums for 2021, and to evaluate whether it is advisable to undertake action to reduce the estimated premiums (e.g., by making additional contributions to the plan or electing the Alternative Premium Funding Target).