Give Employers a Break on Pensions: Charles E.F. Millard
Defined-benefit pension plans are under threat from two powerful forces: the 2006 legislation that was supposed to strengthen them, and the historically low interest rates that are crushing them.
The Pension Protection Act of 2006 was intended to make private-sector plans safer. The law made some improvements. But the pressure it is putting on U.S. corporations is having unintended consequences. Companies are rapidly closing pension plans because of the heavy funding requirements that have only become heavier with low interest rates.
The Society of Actuaries estimates that required contributions from employers will double over the next decade, from the average of $45 billion annually from 2000 to 2009 to an average of $90 billion from 2010 through 2019. If the law is not fixed, the corporate defined-benefit plan will soon be a thing of the past. Provisions were attached to the current Senate highway bill to make some needed changes, but they have to go further.
The 2006 legislation was prompted by the devastating collapse of Bethlehem Steel Corp. and the subsequent bankruptcies of United Airlines and US Airways. Those failures led to tremendous job losses, reduced pensions and multibillion- dollar increases in the deficit of the Pension Benefit Guaranty Corp.
Law of Worst Cases
Bethlehem Steel’s pension plan had been considered “fully funded” under the law at the time. This meant the company made all the required contributions. It didn’t mean the plan was fully funded. The law permitted aggressive valuation of corporate assets and relaxed funding standards. It turned out that Bethlehem Steel’s assets were sufficient to meet only 45 percent of its obligations. United Airlines and US Airways (LCC) faced similar gaps.
George W. Bush’s administration and Congress -- Republicans and Democrats alike -- tried to address this problem. Unfortunately, the legislation was written to cover the worst situations of the past without anticipating those of the present -- in particular the burden that pensions face as a result of interest rates that are at historic and abnormal lows.
To relieve those pressures and make it more attractive for employers to maintain their pension plans intact, Congress should make two changes. It should allow companies to use a multiyear average of bond yields, instead of a two-year average, to calculate their pension contributions, and it should reduce funding requirements from 100 percent of liabilities to something more reasonable.
The law requires that corporations use the rate on high- quality corporate bonds to compute the present value of their pension obligations. The lower those rates are, the higher the stated value of the future liabilities will be. Current low rates are wreaking havoc on pensions’ funded status and corporations’ required contributions. In 2011, the Citigroup Pension Liability Index fell from 5.54 percent to 4.40 percent. That change alone increased pension deficits in the S&P 500 by far more than $200 billion.
This approach is inconsistent with the long-term nature of pension liabilities.
Imagine that a company will owe a retiree $35,000 annually, starting in the year 2030. It can actuarially predict with a high degree of reliability the dollar amount it will owe to the cohort of employees who will retire 18 years from now. Interest rates may rise or fall -- as they surely will -- between now and 2030, but the important thing is whether the corporation and the pension plan will be in a position to meet those liabilities in 2030 and beyond.
The Pension Protection Act doesn’t focus on the likelihood that a corporation can pay those liabilities 18 years from today and in ensuing decades. It focuses on now. It looks at a snapshot when it should be looking at a movie. It doesn’t allow for reasonable smoothing of interest rates, even in today’s extraordinary environment.
I arrived at the Pension Benefit Guaranty Corp. shortly after Congress passed the 2006 act. It was clear to me that the law had been driven by a desire to protect against absolute worst-case scenarios (though it had not anticipated the current one). Sponsors of defined-benefit plans complained to me that the new law would result in the demise of the private-sector pension.
The effects from the rigid rules on interest rates became so severe in late 2008 that Congress gave some temporary relief, but that reprieve lasted only a couple of years. Now, in a low- rate environment even more severe than in late 2008, no relief is available.
The law needs a permanent fix. Besides changing the rules affecting interest rates, Congress should reduce funding targets -- at least for healthy corporations -- to a range of 80 percent to 85 percent, not the 100 percent required today. The real threat to the Pension Benefit Guaranty Corp. and to the recipients isn’t an underfunded pension plan -- it is an underfunded pension plan in a company that goes bankrupt.
By comparison, an individual retirement account isn’t fully funded until the day the individual retires. At that point, it is by definition fully funded -- individual-retirement-account contributions cease and withdrawals begin. But a healthy corporation’s pension plan exists long after the individual has retired. In such a situation, “full funding” is a false target that simply makes it harder for corporations to keep their pension plans going.
A defined-benefit pension plan keeps retirees more financially secure in old age and can help corporations attract employees. To preserve private-sector pension plans, Congress has to act while there is still time.
(Charles E.F. Millard is a managing director for pension relations at Citigroup Inc. He was director of the Pension Benefit Guaranty Corp. from 2007 to 2009. The opinions expressed are his own.)
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