By this time, pointing out that increases in Pension Benefit Guaranty Corporation (PBGC) single employer plan premiums are driving sponsors out of the defined benefit (DB) system is commonplace.

There are, however, some nuances worth considering. And it’s probably time to begin thinking about what’s next—once these premium increases break the current system. In this column I want to discuss two things: the different effects of increases in the flat-rate premium and increases in the variable-rate premium; and possible PBGC endgames.

Department of Labor Employee Benefit Security Administration (EBSA) Assistant Secretary Phyllis Borzi has remarked that “There was never agreement when [the Employee Retirement Income Security Act] was passed and there isn’t agreement now as to what PBGC was supposed to be.” Amen to that. To understand what is going on with the PBGC premium increases I think we need a clear answer to that question—what is the PBGC? In my view, the PBGC single employer system is (i) a tax, the PBGC flat- and variable-rate premiums, and (ii) a benefit, the PBGC guaranty of the sponsor’s pension promise.

From the sponsor’s point of view, the question is, is the benefit worth the tax? And if it’s not, what can the sponsor can do about it (e.g., reduce headcount, terminate the plan or fund unfunded benefits)?

From the PBGC’s point of view, the question is, are the tax (i.e., premium) revenues worth the cost of the benefit (having to pay unfunded insured benefits on plan termination)? And if they are not, what can PBGC do about it (e.g., increase either the flat- or variable-rate premium or vary the premium based on the financial condition of the sponsor)?

Given these incentives, the increases in PBGC flat- and variable-rate premiums have different consequences. The flat-rate premium functions as a tax on headcount. So, ironically (at least for advocates of a broad-based DB system), the incentive for sponsors is to get rid of (cash out) participants with smaller benefits (because the flat-rate premium is a higher percentage of their benefits) and keep participants with larger benefits. More broadly, plans—like those for professional services employers—that benefit a limited number of mainly higher-paid participants (with larger benefits) can sustain the headcount tax. Plans with a lot of participants with more modest benefits will have a harder time doing so, and many of them will terminate—per the predictions of commentators.

All of that will reduce PBGC’s premium revenue, but it will probably also reduce PBGC’s exposure.

The variable-rate premium, on the other hand, is a tax on underfunding. That tax is at 3% for 2016 and is projected to go up to 4.7% by 2023. These increases provide a very strong incentive for sponsors to fund their benefits. We expect any company with a reasonable cost-of-borrowing to do just that. In one respect, that effect—an increase in funding—is benign and even desirable. For PBGC, the problem with this scenario is that over time the only companies left with underfunded plans will be those who don’t have a reasonable cost-of-borrowing.

With respect to PBGC revenues, all of this is just a real life illustration of a version of the Laffer Curve: as you raise taxes (aka premiums), at some point revenues will start to go down, as taxpayers (in this case, DB plan sponsors) take action to avoid taxation.

As long as reductions in PBGC revenues are coupled with reductions in PBGC risk, this process is neutral (or conceivably even positive) with respect to the PBGC system.

It’s not necessarily neutral, however, with respect to the DB system. With respect to (“hard”) frozen DB plans—plans that no longer provide any accruals—the shift of these benefits to the private sector (via pension risk transfers) is, IMHO, a positive development. For sponsors, these are, for the most part, no longer “benefits”—they are just a legacy. Let the private sector handle it.

But to the extent that the increases in flat-rate premiums are driving out “live,” broad-based DB plans, that’s a problem. Somebody needs to take a hard look at that issue. I don’t really see the point of an “insurance” system that only insures plans for professional services corporations. And, btw, I’m pretty sure that the professional services corporation sponsors would agree. Especially since most of those plans are cash balance plans with, generally, a reduced risk of underfunding.

One thing we should all be thinking about: why a headcount premium? Given that PBGC’s exposure is based on benefits up to a certain limit, shouldn’t the flat-rate premium be based on the total insured benefits in a plan? I would also say that there should be a different premium for cash balance plans, given the fundamentally different risk presented by those plans.

The effect of the increases in the variable-rate premium is harder to fathom. The way I think of it, there is a line (“the margin”). On one side of that line are all the companies that can efficiently borrow-and-fund. On the other side are those that can’t. Every increase in variable-rate premiums moves that line farther to the right.

The breakeven point—the point at which it’s cheaper to borrow-and-fund—depends on a number of assumptions, critically the rate of return on plan assets. Assuming a 4% return and taking into account (as of each period) future increases and (where relevant) inflation, I estimate the breakeven point as follows:

Variable-rate premium rules in:

• 2012 (before MAP-21 increases), breakeven is 5.27%;
• 2012 (after MAP-21 increases), breakeven is 6.25%;
• 2013 (after year-end 2013 budget deal increases), breakeven is 7.91%; and
• 2015 (after October 2015 budget deal increases), breakeven is 9.21%.

The puzzle is, as the breakeven point has moved from 5.21% to 9.21%, what happens to the PBGC revenues versus risk equation? If all the sponsors left in the variable-rate “pool” are those whose borrowing cost (in these low-interest times) are above 9.21%, is that a good thing? Someone should be thinking hard about that.

In this context, it’s understandable that PBGC would like to go to a “variable” variable-rate premium, with lower premiums for financially strong companies and higher premiums for financially weak ones. With these dramatic premium increases, that policy is being implemented in a crude way—all the financially strong companies will fund and only financially weak companies will remain.

The last of the multiplying ironies here is that Congress has demonstrated no concern with any of this. It has, since 2013 at least, simply sucked money out of PBGC premium payers as a phony solution to its budget problem.

Unless someone does something about all this, it’s not going to end well.

Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services ­corporations with the regulatory issues facing their plan sponsor clients. He has 30 years’ experience in the benefits­ field, in law and consulting firms.