ERIC Offers T-Bond Alternative

September 4, 2002 (PLANSPONSOR.com) - A retirement-services trade group has proposed an alternative rate for the defunct 30-year Treasury bond rate used to determine pension funding requirements.

The ERISA Industry Committee (ERIC) has proposed instead a composite made up of four corporate bond indices.  ERIC says the new composite measure would use interest rates from long-term, high yield corporate bonds, to help beef up employee retirement security.

The new composite will be used to calculate pension liabilities, which in part, helps set the amount employers have to contribute to their plan.

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ERIC has proposed that, at least initially, the composite be comprised of:

  • Moody’s Aa Long Term Corporate Bond Index;
  • Merrill Lynch 10+ High Quality Index;
  • Salomon Smith Barney High Grade Credit Index; and
  • Lehman Brothers Aa Long Credit Index.

According to ERIC, rates on the 30-year bonds have plummeted after the US Treasury Department stopped issuing them. As a result, liabilities are artificially inflated and employers are required to pay millions of dollars in unnecessary contributions to their pension plans, the group said.

“Using the defunct Treasury rate unnecessarily diverts scarce corporate cash from jobs, product development and other business activities needed to get our economy moving,” Mark Ugoretz, president of ERIC, said in a statement.  “It also tells employers that maintaining a defined benefit pension plan is not a sound business investment.”

Lump-Sums Bump

According to the ERIC proposal, the low rates of the 30-year Treasury bond have also distorted benefit payments by inflating the size of lump-sum distributions from traditional defined benefit plans.

These artificially inflated lump sums have discouraged workers from electing to take their benefits as annuities – contrary to federal retirement policy – and have imposed substantial and largely unanticipated cash demands on pension plans, ERIC agued.

Phased Phases

ERIC says the new interest rate should be phased in over a three-year period for purposes of calculating the minimum lump-sum payment under a pension plan, moderating the effect on lump sums of shifting from the 30-year rate to the Composite Rate. However, employers would get immediate relief under ERIC’s proposal, which does not call for a phase-in period with application of the composite rate to minimum funding standards or the variable rate premium.

ERIC has also recommended a change in the so-called volatility rule, so that a plan will be exempt from the quarterly contribution requirement if the plan is at least 80% funded and is at least 90% funded for at least two of the immediately preceding four plan years.

  • replace the 30-year Treasury rate wherever it appears in current law with a composite corporate bond rate composed of four corporate bond indices
  • coordinate the new rate with related mortality assumptions
  • phase in the new rate for lump sum calculations
  • reduce the frequency by which employers bounce in and out of current liability funding and quarterly contribution requirements.

Congress, recognizing the severity of the low interest rates of the 30-year Treasury, passed as part of the economic stimulus package in March 2002, a stopgap measure that increased the range of permissible interest rates for use in pension funding.  That measure will expire at the end of 2003.

A copy of the ERIC proposal and supporting data can be found on the ERIC website at  http://www.eric.org/pension_funding_proposal.pdf and  http://www.eric.org/BackgroundMaterials.PDF.  

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