ABC Points to Significant Threats Endangering the DB System

“The greatest threat to defined benefit pension plan sponsorship is not cost, but uncertainty and volatility,” said the American Benefits Council’s President James Klein.   “For years the focus has been on cost as the reason we have moved from defined benefit to defined contribution plans. True, defined benefit plans are expensive. But that is only part of the story. It is the uncertainty about the future rules governing pensions that has caused employers to exit the system.”

The uncertainity surrounding the system currently comes in the form of specific threats outlined in a report released by the national trade association entitled Pensions at the Precipice: The Multiple Threats Facing our Nation’s Defined Benefit Pension System.   High among the issues currently threatening the defined benefit system in the United States are:

• an assault on hybrid plans
• the failure to permanently replace the obsolete 30-year Treasury rate for pension calculations
• a flawed pension funding regime and flawed proposals for funding reform
• a movement to impose marked-to-market accounting standards.

Further, to prevent companies and employers from being “flung into the culvert where defined benefit plans simply are no more,” ABC provides policymakers with some policy actions to address the major threats outlined in the report.

“Today,” Klein added, “defined benefit plans face an unprecedented series of policy and legal threats that endanger their continued existence.”

Hybrid Assault

Paramount among the threats to hybrid plans across the country, a category that includes cash balance pension plans, was the ruling by U.S. District Judge G. Patrick Murphy in the U.S. District Court of Southern Illinois last July (See  Murphy’s Law: IBM Loses Cash Balance Ruling ).   In his ruling in Cooper v. IBM, Murphy held that IBM violated age discrimination laws by amending its pension plan in a way that would make older employees accrue retirement benefits at a lower rate than younger workers. 

The ruling’s impact further rippled into the halls of the U.S. Congress, when Representative Bernard Sanders (I – Vermont) and Senator Tom Harkin (D – Iowa) included a provision in the Fiscal Year 2004 Omnibus Appropriations Act denying funding to the Treasury Department to complete pending age discrimination regulations.   Prior to the provision being stapled onto the funding bill in December 2002, the Treasury Department and the Internal Revenue Service (IRS) proposed regulations addressing the age discrimination requirement for cash balance and other retirement plans.

Addressing the issue of the assault on hybrid plans, ABC recommends Congress lift the prohibition on the Treasury Department’s completion of the age discrimination regulations.    This, in turn, would allow the Treasury Department to clarify “that the cash balance pension equity plan designs are not age discriminatory,” the ABC’s report stated.   Failing action by Congress to lift these restrictions imposed on the Treasury Department, ABC says Congress must act to “clarify the age appropriateness of these designs under the current law.”

ABC says"of the many threats facing the defined benefit system, one of the most pressing is the need for a permanent replacement for the obsolete 30-year Treasury bond interest rate for pension calculations."   To some extend, ABC got its wish in April, when the President signed into law legislation in April 2004 providing a replacement to the 30-year Treasury rate for 2004 and 2005 based on a blend of corporate bond indices (See  Whew! Bush Signs Pension Relief ).  

However,the Pension Funding Equity Act (H.R. 3108), only provides a fix for two years; 2004 and 2005.   To this, ABC says, " Companies that sponsor defined benefit plans need to be able to plan for future pension costs," and while this task is challenging under ideal circumstances, it becomes "completely impossible when the rate used to measure those costs is not known for more than two years out."

Additionally, the failure to fix the issue on a long-term basis runs the risk of reverting back to the 30-year Treasury rate that the most recent legislation seeks to avoid.   Thus, ABC "urges Congress" to make the corporate bond rate the permanent solution and "to do so quickly."

Pension Funding Problems

One of the problems high on the ABC's radar screen is legislative rules that do not allow companies to fully fund pension plans when the money is there.   Rather, the rules that lowered maximum tax-deductible contribution, imposed a significant excise tax on contributions that were not tax-deductible and placed heavy penalties on employer withdrawals of surplus assets that serve to "discourage employers from contributing to their pension plans."  

In turn, these rules, discouraging pension plan funding during "good economic times," combined with historically depressed asset values and low interest rates during the 2000-2003 period have put a large financial strain on the nation's private pension insurer, the Pension Benefit Guaranty Corporation (PBGC).   With the PBGC taking over more, and larger, troubled pension schemes in recent years, the agency has moved from a net surplus to a net deficit (See  GAO Designates PBGC 'High Risk').   However, ABC is not nearly as concerned about the PBGC's funding status as the interest group is concerned about the declining number of pension plans offered by employers that pay the premiums necessary to support the PBGC's insurance guarantee mechanism.  

Thus, ABC said Congress need to "focus on constructive reforms to the current funding rules to encourage more employers to sponsor defined benefit plans."   As an example, ABC suggests allowing for more regular and predictable contributions regardless of the funding status of the plan could reduce pension-funding volatility.  

Mark-to-Market

Under the current pension accounting rules, outlined in Financial Accounting Standards   (FAS) No. 87, employers are allowed to "smooth" pension asset gains and losses over time.   However, the Financial Accounting Standards Board (FASB) and its global accounting rulemaking couterpart, the International Accounting Standards Board (IASB), are currently considering changes to the standards to prohibit the utilization of smoothing techniques.

ABC says such a move would be disastrous, since a mark-to-market approach to valuing asset gains and losses would "dramatically increase the volatility of pension expense," the report says.   To alleviate any potential problems, ABC urges accounting standard setters to be "extremely cautious when evaluating" a mark-to-market approach, since such an approach could "lead to a reduction in the pension promises made by employers to better insulate themselves from the volatility injected into pension funding."

In addition to threats and policy recommendations, the report provides background on defined benefit pension plans and the defined benefit system.   A copy of the full report is available  here .