White House might be in mood to deal

WASHINGTON — Less than two weeks after unveiling an ambitious pension reform package, senior Bush administration officials are hinting at concessions they're willing to give employers to make the stringent proposals palatable.

Employer groups have begun drafting their own revisions they'd like to see in the reform package, and are already expressing doubts that negotiations over the package will result in a compromise this year. A more reasonable goal, they say, would be an extension of the temporary law, which expires at the end of 2005, that allows employers to link the value of their pension liabilities to corporate bonds, giving more time to debate the administration's proposals.

It's going to be "tough sledding" to get reform enacted this year, said Brian H. Graff, executive director of the American Society of Pension Professionals and Actuaries, an Arlington, Va.-based trade group.

"It's not going to fly in its current form, so the question is whether we can come up with something … less than the administration's (package) but more than current law."

James M. Delaplane Jr., partner in the Washington law firm Davis & Harman LLP, concurred: "It's a radical reform, and radical reform tends to be difficult to move in a short time period."

What's radical about the package announced by top administration officials on Jan. 10 is that it would scrap existing pension funding rules and require companies to value their liabilities along a yield curve of corporate bonds. And, for the first time, the proposals link insurance premiums for the Pension Benefit Guaranty Corp. to the creditworthiness of the plan sponsors. PBGC premiums for fully funded plans would rise to $30 per participant from $19; subsequent increases would be tied to inflation. Sponsors with below-investment-grade credit ratings would pay higher, "risk-based" premiums.

Employers worry the proposed reforms to improve plan funding and shore up the PBGC would have the unintended consequences of accelerating plan terminations of traditional defined benefit plans and/or requiring employers that continue their plans to sell off trillions of dollars in stocks.

To ensure their plans stay fully funded, employer groups say, corporations would have to forsake the higher returns on equities and invest in lower-risk, lower-return securities such as bonds, which move in sync with pension liabilities.

And financially weak companies might terminate their plans sooner than they otherwise might have, before the more stringent rules become effective.

Instead of investing their pension assets in stocks, companies will simply shut down their pension plans, set up defined contribution plans, and "let the employees invest in stocks," said Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries in Washington. He agreed the administration needs to soften its proposals considerably before employers will accept them.

In an interview, Mark Warshawsky, assistant Treasury secretary for economic policy, listed the concessions the administration is willing to make. At the top of the list: letting employers use surplus pension assets to pay for unrelated employee benefits.

Employers are worried that the administration's rewrite of pension funding rules could cause them to accumulate large surplus assets over time — current deficits notwithstanding — without any way of drawing down that money.

The Employee Retirement Income Security Act forbids employers from tapping pension funds to pay for any other purposes, although employers may draw down a limited amount of assets in excess of 125% of current liabilities each year to pay for the current year's retiree medical expenses. Under current law, companies can only access their pension surpluses by terminating their plans and paying steep taxes and surcharges — as high as 80% of the surplus in some instances.

But the effort by the administration to appease pension plan sponsors could once again become a lightning rod for controversy because of the debate over whether excess pension assets belong to the employer or to employees, and over the share of the surplus owed to retired workers. Despite a 1999 Supreme Court decision in Hughes vs. Jacobsen, that stated surplus assets belong to employers, the issue continues to plague companies.

Mr. Warshawsky told Pensions & Investments that the administration is "open to discussions with Congress and plan sponsors and unions and others about the availability to use the money for other purposes."

Bill Gulliver, chief actuary at employee benefits consultant Towers Perrin, Stamford, Conn., is one of those interested parties. "If you expect plans to be fully funded on a solvency basis, they should be allowed to use the surplus funds for other purposes, such as paying health-care benefits, and other compensation and benefit needs without incurring tax penalties," he said.

Other bones the administration is throwing plan sponsors include assessing risk-based PBGC premiums only if all three of the major credit rating agencies downgrade the company's debt to below investment grade (The PBGC would compute the debt rating for companies whose debt is not rated by the credit agencies.)

Additionally, the administration is willing to let employers use a stripped down yield curve to calculate lump-sum payouts to departing employees.

But the administration is so far unmoved by employers' pleas for a simplified yield curve of corporate bonds to calculate liabilities using different interest rates for short-, intermediate- and long-term liabilities, instead of basing their liabilities on spot interest rates matched with the duration of liabilities. Employers worry that moving to the yield curve from a four-year average could result in their having to fund their pension plans against a constantly moving target.

"Volatility and predictability are critical issues to us," said Lynn Dudley, vice president and counsel at the American Benefits Council, Washington.

Mr. Warshawsky said the administration is not ready to concede on that issue.

"We are not convinced it is warranted at this point," Mr. Warshawsky said. "We are dealing with very educated actuaries, and this is a very simple spreadsheet."

But Mr. Gebhardtsbauer was blunt: "The yield curve is not going to be palatable." Employers, he said, "will want something smoother."

Employers also would like the ability to contribute stable amounts to their pension funds over as many as 10 or 15 years to make up their shortfalls, instead of the seven to 10 years proposed, because of their fear of volatility of contributions. Mr. Gebhardtsbauer suggests capping how much contributions could increase or decrease from one year to the next to limit volatility.

But Mr. Warshawsky said the administration is giving employers tools to manage volatility. "The plan sponsor has a lot of choices in terms of asset mix and benefits, and they have to make choices."

Mr. Gebhardtsbauer said employers also will want benefit freezes to be based on an average funding level over a year, so that employees are not confused by freezes being turned on and off as the sponsor's funding ratio moves up or down.

Also on employers' wish list are requests to be able to carry forward credit balances sponsors have built up for contributions made to date, and for the PBGC to disclose how it invests its portfolio.

The administration's pension reforms would gut the current funding rules, replacing multiple measures of pension liabilities with a single measure, adjusted to reflect termination risk. Companies would plot their liabilities, based on the demographics of their work force, along a yield curve of corporate bonds. And they would be required to value their pension liabilities at current value, instead of using a four-year average. Assets also would be valued at market.

The proposed funding rules also would substitute a single method for calculating contributions from the various minimum and maximum contribution calculations provided under current law; and companies would be expected to contribute the necessary amount each year to meet 100% of their accrued liabilities, but could make tax-deductible contributions of up to 130% of their projected liabilities.

But, the proposals put stringent conditions on companies whose debt ratings slip below investment grade.

Companies with junk bond status for five or more years would be required to assume all employees will take lump sums and retire at the earliest possible age. Also, financially troubled companies would not be able to promise additional benefits or give lump sums, and companies in bankruptcy would be required to freeze their plans.

PBGC premiums would be based on the credit ratings of plan sponsors, a proxy for the risk of terminating their plans. Sponsors of underfunded plans would pay "risk-based" premiums per $1,000 of underfunding; the PBGC board would have the discretion to hike those premiums.

What's more, employers would be required to disclose the funded status of their pension plans to employees on a regular basis; information about underfunded plans would be publicly disclosed.

But the administration's proposal stopped short of considering how pension assets are invested in computing a sponsor's risk levels. And the PBGC, which had sought greater enforcement authority in 1994, backed off now from seeking authority to halt mergers and acquisitions involving companies with underfunded plans.