Treasury Secretary Steven Mnuchin and Federal Reserve Chairman Jerome Powell have both said that they believe Congress will need to pass additional coronavirus-related economic stimulus legislation. In the meantime, the House of Representatives has already passed such a bill that includes temporary relief from numerous burdens. Among those burdens is one that Congress itself has placed on pension plans in the past. Instead of providing temporary relief, Congress should take this opportunity to undo some of the damage it has done to the defined benefit pension system.
In the Pension Protection Act of 2006, Washington unwittingly encouraged the demise of the traditional private-sector defined benefit pension plan by placing onerous funding burdens on the corporations that sponsor them. Since then, it has repeatedly waived those provisions because they are overly burdensome and make it harder for corporations to maintain their pension plans.
Temporary relief is sensible. But it would be even more sensible for Congress to recognize its past mistakes, throw in the towel and finally make relief permanent. Allowing longer periods of time to calculate and amortize liabilities would make it easier for corporations to keep their pension plans in place. Congress should take this opportunity to put those provisions into the law.
In the PPA, Congress sought to impose pension plan "reforms," but those reforms turned out to be counterproductive. Instead of encouraging corporations to fund and maintain healthy pension plans, these efforts made them too expensive, unpredictable and volatile. The result: Employers are freezing, cutting or ending their pension plans. According to Willis Towers Watson, the number of active defined benefit plans for salaried workers in Fortune 500 companies fell from 218 in 2006 to 70 in 2019.
To understand how that happened, history helps. In 2001, Bethlehem Steel Corp. filed for bankruptcy, causing the loss of many thousands of well-paying blue collar jobs and many billions of dollars in reduced pension benefits. Moreover, it turned out that while Bethlehem Steel had made all of its required contributions under the existing ERISA rules, in reality, the pension plan was only 45% funded, resulting in further reductions for many workers and a multibillion dollar increase in the Pension Benefit Guaranty Corp.'s deficit.
At that point, one goal became paramount: make sure that this does not happen again. So Congress made two big changes.
One important step was to measure liabilities "properly." If you are trying to close the gap between assets and liabilities, you have to be able to measure the liabilities. The "proper" measure of liabilities is widely debated. A defined benefit liability should be considered a debt of the corporation. As such, it might be measured by the corporation's cost to borrow. So, Congress required that corporations apply a discount rate that is, essentially, a two-year blend of AA corporate bonds (today that would be about 3.8%.)
Secondly, Congress decided that all corporations should be on a path to fully amortize their pension obligations within seven years.
These two changes could not have come at a worse time. They were to take effect in 2008 — what turned out to be the global financial crisis. So, wisely, at the end of 2008, Congress passed temporary measures that gave relief from some of those burdens.
Going forward from the GFC, a strange thing happened: interest rates (and, therefore, discount rates) kept falling. So, in 2012, things were even more difficult for plan sponsors. AA corporate rates were at historic lows (or at least they seemed historic then!), and funding obligations were even more difficult to meet.
Imagine you were a CFO at that time. Your pension plan CIO comes to you and says we are 80% funded (let's say $800 million in assets and $1 billion liabilities). The CIO says we must amortize $200 million over seven years (like a seven-year mortgage), so you make the contribution of about $34 million. A year goes by, and the CIO comes and tells you there is good news and bad news. The good news is the pension assets returned 10% for the year, so they are now worth $880 million; that $880 million, plus last year's $34 million, puts our assets at about $914 million.
The bad news? The discount rate by which we measure our liabilities dropped by 1 percentage point. That means our liabilities are now $1.15 billion. So, even though we did great, our gap got bigger, and this year we need to put in over $4 million more than last year! No wonder General Motors and Verizon concluded a massive buyout of liabilities in 2012, leading the way for dozens of similar pension risk transfers.
That same year, Congress took further action. It temporarily allowed smoothing of discount rates, so that in times of dropping rates, sponsors could avoid some extreme volatility and, in times of rising rates, sponsors would continue to have significant funding obligations even if their plans appeared to be much better funded.
But Congress giveth and Congress taketh away. At the same time that it gave some interest rate relief, it also increased PBGC premiums, continuing to make the maintenance of pensions expensive for plan sponsors.
Sadly, the increase in premiums and the funding obligations of plan sponsors were not even driven by a coherent policy about pension plans. It was all about the budget and Washington math. If plan sponsors put less in their plans, that is less in tax deductions and more in "revenue" to the government. Similarly, increases in PBGC premiums (even though they go to the PBGC and not to the Treasury) are counted in Washington math as federal revenue, and this helps create "payfors" in budgeting. An indication that this was not really pension policy: these proposals helped pay for highway funding.
Two years later, with interest rates continuing to fall, Congress extended its "temporary" smoothing. And the following year — you guessed it — rates kept falling and temporary smoothing was extended. In the years since then, Congress has also exempted various industries from these requirements as well, because they are too difficult to meet.
The coronavirus relief bill recently passed by the House proposes another temporary reprieve. It calls for temporarily extending interest rate smoothing relief (again) and allowing temporary use of a 15-year amortization rather than seven years. Congress should just go ahead and adopt those provisions permanently.
Why would we require seven-year amortization of a liability that will be paid over many decades anyway? When markets and asset values fall, it becomes immediately more expensive to meet funding obligations, as though there were a looming deadline seven years away, But these liabilities are mostly decades away, and there are many years available to amortize them.
Regarding interest rate smoothing, remember that pension funding is not a snapshot, it is a movie. Pension plans do not need to be fully funded at any given moment. They should be well-funded, but full-funding is an unnecessarily onerous goal. Their liabilities need to be paid over time. Discount rate smoothing ensures that it is a bit easier for employers to fund when rates are low. It also ensures that they continue to fund when rates are higher (which, one day, they will be).
These two measures would make it more likely that corporations keep their pension plans intact. These provisions represent proper and coherent pension policy and should be made permanent.
Charles E.F. Millard is senior adviser for Amundi Pioneer Asset Management. He is former director of the U.S. Pension Benefit Guaranty Corp. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.
