$40 Billion Short?

Yes--unless Congress acts fast to change pension law

With their earnings withering in a weak economy and their banks getting stingier with loans, America's companies have been fighting for months to conserve cash. Next year, whatever they have scraped together could fly out the window. Unless they can prod Congress to act quickly, businesses may have to pour as much as $40 billion of cash into needless contributions to top off their defined-benefit pension plans, according to pension consultants Watson Wyatt & Co.

The problem is that the yields, or effective interest rates, on 30-year U.S. Treasury bonds play a crucial role in federal pension law. The Internal Revenue Service forces companies to use a four-year average of the long bond yields to figure out if their pension plans are adequately funded--even if their investments are earning higher returns. The lower the yields, the more the plans have to pump up to meet potential future payouts. Lately the yields have been pushed down as bond prices were bid up. This is because long bonds have been in short supply for months. The last straw came on Oct. 31 when the Treasury announced that it will no longer issue 30-year bonds.

NO CHOICE. The bottom line is that long-bond yields are a full percentage point too low compared with similar corporate bonds, according to the American Academy of Actuaries, whose members do many of the calculations for defined-benefit plans. Under current law, though, companies can't use a more realistic substitute, such as top-quality corporate issues. The rules have no bearing on 401(k) defined-contribution retirement plans.

For the average pension scheme, the one-percentage-point error exaggerates the current value of its future obligations by 12% to 15%, says Ron Gebhardtsbauer, senior pension fellow at the academy. Companies are leery of discussing their own situations, but actuaries describe a manufacturer that will have to cough up $40 million, a food-service company that will owe $60 million, and a consumer-goods company facing an $85 million tab. In one extreme case, an employer will have to contribute $10,000 for each worker. "Unless the funding requirements are adjusted, industry could find itself laying off more people at the same time it is forced to overfund pension plans," warns William R. Timken Jr., chairman and chief executive of the Timken Co., a Canton (Ohio) bearings maker.

Other types of organizations, such as charities, will be hit, too. The United Jewish Appeal-Federation of Jewish Philanthropies of New York is facing a $10 million increase in its contribution next year over and above the $7 million actuaries believe is needed to cover its obligations. That's more than $1,400 for each of the 7,000 employees covered.

Unnecessary makeup payments are just the start. Some companies will be socked for higher insurance premiums by the Pension Benefit Guaranty Corp. (PBGC), charged by the government with making good on plans of bankrupt companies. Annual premiums are $19 for each person covered by a plan, plus about 1% of the underfunding. Once their plans become underfunded, companies may face a raft of bureaucratic entanglements with the PBGC, warns Mark Beilke, an actuary at consultant Milliman USA. For instance, they may have to give 30 days' advance notice of any takeover deals.

UGLY SURPRISE. Companies struggling to cut costs by firing employees will get a nasty surprise, too. They'll have to pay out much bigger lump-sum benefits to people leaving their plans. For a 45-year-old employee, for example, the payment will be 30% higher, says Gebhardtsbauer.

Government officials say the PBGC, the Labor Dept., and the IRS are reviewing alternatives to long-bond yields, although they won't give details. Private experts say one solution would be to use a rate tied to the higher yield on Moody's Aa Corporate Index, a measure widely used to figure pension liabilities for financial reporting.

Even if government experts come up with a solution promptly, it may not be soon enough to ensure quick congressional action. "If they don't get it changed in the economic stimulus bill before they go home for Christmas, it is not clear when the next opportunity is," says James Delaplane, a lobbyist for the American Benefits Council industry group. Waiting until next year would mean making any change retroactive, a messy way to legislate that would at best muck up corporate cash-flow planning for months and at worst increase the need for economic stimulus.

By David Henry in New York

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