As executives at corporate defined benefit plans figure out whether they gained more than they lost in pension legislation approved by Congress June 29, one clear winner emerges: Uncle Sam.
If plan executives take advantage of the bill's longer-term interest rates for calculating pension funding obligations, giving them a chance to save on contributions in the short term, the federal government could see tax revenue increase more than $9 billion over 10 years as tax-exempt contributions dip.
Another $9 billion will flow to the Pension Benefit Guaranty Corp. through increased premiums.
“The government wins both ways,” said Bruce Cadenhead, partner and chief actuary for Mercer's U.S. retirement, risk and finance business.
As for pension funds, Mr. Cadenhead noted: “Some employers really see no benefit, while there will be others, especially those struggling to make minimum required payments, who think the near term cash (benefit) is significant.”
The bill, Moving Ahead for Progress in the 21st Century Act, or MAP-21 that included the pension changes was signed by President Barack Obama on July 6.
The bill also contained new governance procedures for the PBGC, including a risk management officer for the agency's $73.3 billion portfolio, tighter conflict-of-interest controls, an advocacy office for participants and plan sponsors, and peer-review of plan modeling assumptions by other government agencies.
For corporate plans, the biggest positive change was interest rate stabilization. Since the 2006 passage of the Pension Protection Act, most plan sponsors have had to use discount rates based on a two-year average of corporate bond index rates to calculate their pension liabilities and figure out their funding obligations each year. The rates were further broken depending on the maturity of the plan and when payouts are due.
In the current low-rate environment, the first segment rate for valuing liabilities due in the next five years is a rock-bottom 1.98%, while the highest rate is 6.19%.
But under the new law, sponsors can take a 25-year historic average of corporate bond rates to determine a rate within a 10% range, or corridor, of the two-year rate.
Using the higher rates could reduce liabilities by 10% to 20%, estimates Donald Fuerst, senior pension fellow at the American Academy of Actuaries, Washington. The effective rate used now averages 5.3%, while the new discount rate will average 6.7%. “For some plans, it could make their entire underfunding problem disappear — for a while,” Mr. Fuerst said in an interview.
Savings up to $100 billion
Mercer estimates pension plan sponsors in the S&P 1500 could save as much as $50 billion in 2012 and $100 billion through 2014. The relief dwindles after that because the corridor increases by five percentage points per year until hitting 30% in 2016.
Whether those changes make a meaningful difference depends on each company's situation, including how underfunded its plans are and how tight cash is at the moment.
“Those who really need it, need it,” said Jeffrey Litwin, senior vice president and consulting actuary with Sibson Consulting, a Segal Co. division in New York. “This is real relief, but for a small segment.”
Mr. Litwin and others also worry that plan participants will be more confused by new provisions requiring disclosure about both the old and new rate calculations in annual funding notices, especially since the relief is temporary.
“Two years from now, we're going to be debating the issue again,” said Mr. Fuerst. “I hope at that time, we can actually do it in a better way.”
Another concern is whether the rate relief lets plan sponsors lose sight of their long-term funding obligations. That is not likely, said Deborah Forbes, executive director of the Committee on Investment of Employee Benefit Assets, Bethesda, Md., which represents more than 100 of the largest U.S. corporate plan sponsors with $1.5 trillion in defined benefit and defined contribution plan assets. “Most plan sponsors want to fund their plans responsibly,” Ms. Forbes said.
The higher funding calculation rates could throw off liability-driven investing strategies, said Karin Franceries, executive director in J.P. Morgan Asset Management (JPM)'s strategy group in New York, who calls the changes in the discount rate calculations a “pension Botox” that wears off in a few years.
Double the work
Chief investment officers will have twice the work when it comes to risk management of pension assets, she said. That's because unlike the regulatory change, “in an accounting framework, liabilities remain sensitive to rates, and that hasn't changed. It (the new calculation) is not the reality. You still have the liabilities. The CIO's role is more complicated than it was” before the bill was passed, Ms. Franceries said.
But as plan executives celebrate the immediate rise in the funding levels of their defined benefit plans that the legislation provides, they are bracing for a higher bill from the PBGC.
Premiums for single-employer plans will increase to $42 from $35 per participant in 2013 and to $49 in 2014, after which the premiums will be indexed for inflation.
Variable-rate premiums, based on the degree of underfunding and now are $9 per $1,000 of unfunded benefit, will be indexed for inflation with more hikes in 2014 and 2015. Plan sponsors will have to wait for the PBGC to calculate the new rate each time it gets indexed.
Unlike Congress' “calm and sensible approach” for rate stabilization, the premium hike was “disappointing,” said Lynn Dudley, senior vice president of policy for the American Benefits Council, Washington. “Congress has not delved into the underlying reasons behind the (agency's) deficit besides just awarding more money to the PBGC.”
Even PBGC Director Joshua Gotbaum was not happy with the premium hikes. “Three-quarters of companies are financially sound. They should be rewarded with lower rates and less hassle,” Mr. Gotbaum said in an e-mailed statement.
Mr. Gotbaum wants to recalculate the premium formula to reward healthy plans and make riskier ones pay more; he also wants Congress to transfer premium-setting authority to the PBGC.
In addition, the governance changes could also give more insight into the way the agency works and ease concerns raised by the inspector general about quality control and plan assumptions. “We think this is a really important step forward,” said Karen Friedman, policy director at the Pension Rights Center in Washington.
This article originally appeared in the July 9, 2012 print issue as, "Pension legislation winner: Uncle Sam".