Providing funding relief for corporate pension plans sounds reasonable enough that even the AFL-CIO is cautiously behind the idea of a Senate proposal included in the highway funding bill passed last week.
But pension activists and some ratings agencies worry that unintended consequences could make pension underfunding an even greater threat down the road, while proponents of liability-driven investing warn that relief could create more risk for plan beneficiaries by forcing plan sponsors to rely even more on investment returns to reduce their funding gap, and throw LDI off track.
The sensitivity of interest rates for pension funding was made clear in a special report issued in February by Fitch Ratings, which predicted that pension liabilities in 2012 could jump thanks to historically low discount rates used by companies to calculate those liabilities. New York-based Fitch estimated that if all other things were equal and investment returns remained lackluster, a one-percentage-point drop in the discount rate could cause liabilities to rise 10% to 20%.
Currently, discount rates are based on a two-year average of bond index rates, which are being kept low by the Federal Reserve at least through 2014. The prospect of depressed rates convinced the Senate on March 14 to approve a provision in the highway funding bill that would allow plan sponsors to calculate contributions with interest rates over a 25-year average, with some restrictions.
In 2012, the calculation would have a 10% corridor, or reduction, in that 25-year average. The relief diminishes in subsequent years, with the 10% corridor increasing five percentage points per year until it hits a permanent rate of 30% in 2016.
The proposal gained tepid support from the AFL-CIO. “We didn't oppose their request, but we had hoped to pair it with some participant protections,” AFL-CIO legislative representative Lauren Rothfarb said in an interview. “We recognize employers' concerns that their contributions for 2012 and later will be very high because of increasingly low interest rates.”
But despite having to pay more taxes, corporations are happy to have more stable interest rates for their pension calculations. “It will make a big difference for some of my members in how they can budget and manage their cash flow,” said Deborah Forbes, executive director of the Committee on Investment of Employee Benefit Assets, Bethesda, Md.