Corporate pension sponsors are being hit by a triple whammy: poor earnings due to the recession; a huge drop in the market value of pension assets because of a badly performing stock market over the last two years; and what's probably going to be a big rise in pension contributions due to the very low 30-year Treasury bond rate.
One reason the 30-year T-bond rate is so low is that the bond is being phased out, meaning it will not be available as a benchmark for the valuation of pension liabilities by the PBGC and pension plan sponsors.
Yet Congress has been paralyzed when it comes to substituting a new benchmark rate for calculating pension obligations, waiting for guidance from the Department of Treasury, which hasn't come up with a recommendation the pension community will support. The delay risks keeping a replacement rate out of not only the economic stimulus bill, which itself may never get enough votes to pass Congress, but also out of the so-called extenders legislation, a routine measure concerning tax and other regulatory matters to be adopted at the end of the year.
The solution is simple. Congress should adopt a temporary rate for two or three years. In the interim, it should convene a panel of experts to come up with a long-term rate that secures pension benefits without imposing an unnecessarily onerous financing burden on employers. Such a rate will leave employers with more cash to invest in their businesses and keep more of them from chucking their defined benefit plans, fed up with the rising cost and possibly huge liability.
The panel should include plan sponsors, labor representatives, actuaries, financial and investment managers, and academics. It should recommend a permanent rate or methodology for discounting pension liabilities. A long-term market index rate, blending government and corporate securities, sounds good.
But what should the interim rate be? So far, Treasury officials have opposed the Moody's Aa rate - now about 7.3% - endorsed by the ERISA Industry Committee, Washington, because the government doesn't control the makeup of the Moody's index of corporate bonds. But the 30-year rate, or any pure government rate, is subject to manipulation, too, the ultimate being discontinuing the long bond.
In turn, the ERISA committee proposed a fixed interim rate of 7% over the next three years; the Treasury has yet to act on that idea.
Without any rate, plan sponsors will have to still use very low 30-year rates to discount their pension liabilities, causing an increase in liabilities and moving some plans to perilous funding levels. This increase likely would trigger an increase in pension contributions, which aren't necessary for the security of the plans. The liabilities are long-term claims that shouldn't bounce around in value because of an abrupt change in government bond financing policy.
The delay in adopting a substitute rate could cost defined benefit plans sponsors $40 billion more in total pension contributions, as well as higher Pension Benefit Guaranty Corp. premiums and larger lump sum payments, according to Watson Wyatt Worldwide.
The delay could move some pension funds to underfunded from overfunded status, forcing plans to make even larger PBGC insurance payments. Companies also would have to place pension liabilities on their corporate balance sheets, worsening their standing with investors and creditors.
If Congress doesn't pick a temporary substitute for the 30-year Treasury bond soon, more corporate sponsors might give up and freeze their defined benefit plans. Mark J. Ugoretz, executive director of the ERISA Industry Committee, said none of its members has plans to terminate defined benefit plans, but small and mid-sized companies might do so.
When Ronald J. Ryan, president of Ryan Labs Inc., a bond manager, calls the 30-year Treasury bond "sacred ground," you know discontinuing it unequivocally will disrupt a way of life in the capital markets.
The 30-year rate is a big deal. Its loss affects not only asset pricing and investment models but also discount rates set by law, especially pension liabilities.
The original concept behind pension funding laws was to allow employers to set their budgets over time, with flexibility so they could fund more in good times and less in bad times. Government officials tend to forget the original intent of many things over time.