Companies Get Caught in the Pension Vise

New rules and low rates mean substantially higher contributions

General Electric, Boeing, 3M, and other U.S. employers with the 100 largest defined-benefit plans will make record pension contributions of $100 billion in 2012, 67 percent more than two years ago. It may take total contributions of $400 billion from 2011 through 2015 to ease underfunding at the plans, according to consulting firm Milliman. “It’s been called the wall of contributions,” says Alan Glickstein, a senior retirement consultant at Towers Watson in New York. “All of a sudden this thing jumps up and stays there for a few years.”

Companies are caught in a vise: The Federal Reserve has said it expects to keep rates at current levels until 2014 means pension plans’ fixed-income investments are stagnating just as federal rules shorten the time available to shore up funding. Under the federal Pension Protection Act, which was passed in 2006 and mostly took effect in 2008, tighter accounting rules gave employers seven years to fully fund their retirement plans and required them to use a specified, market-based rate of return to compute liabilities instead of a company estimate.

To calculate its liabilities, a company starts by projecting future payments. It then determines how much money it must set aside to meet those obligations, using interest rates pegged to a basket of corporate bonds. Lower rates mean the company has to allocate more money. The Fed has held its discount rate at 0.75 percent since February 2010, down from as high as 6.25 percent in June 2007. The Fed said on Jan. 25 it expects rates to stay at current levels until 2014.

3M’s pension plan for U.S. workers, which began 2011 with assets of $11.6 billion, shows the challenge. Assets rose to $12.1 billion by yearend because of investments and contributions, even after payouts of $680 million, according to a Feb. 16 filing. Meanwhile, the funding shortfall more than tripled, to $2.4 billion, because with today’s low rates, the amount the plan needs to be fully funded rose 18 percent, to $14.5 billion.

The money that companies have to add to pension funds is money that won’t go back to shareholders through dividends or buybacks or toward expansion, says Kevin McLaughlin, a pension-risk management specialist with consultant Mercer in New York. With Fed Chairman Ben Bernanke keeping interest rates low, McLaughlin says the situation won’t change anytime soon. “Right now, everybody is hoping for the best,” he says, “which is equity markets performing and interest rates not falling any lower.”

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