Experts Say Administration Pension Proposal A Step in the Right Direction, But…

Overall, sentiment among the consulting community seems to be that the administration is taking positive steps to modify the convoluted current system.   Nonetheless, more steps need to be taken before plan sponsors can evaluate the full impact of the Bush proposal.

“The administration is to be commended for producing a proposal that will help move the legislative process forward and for supporting the use of a long-term corporate bond interest rate for all pension calculations in place of the obsolete 30-year Treasury bond rate,” said James Klein, president of the American Benefits Council (ABC), an employer trade association.   “However, there are serious concerns with the administration’s proposal,” Klein continued.

Current Calculations

Since 2002, companies have been operating under temporary relief through an expanded range around the now defunct 30-year Treasury rate used to calculate defined benefit funding status – relief that is set to expire at the end of 2003.   That rate has dropped to record, albeit artificial lows in recent years, in effect inflating the amount of cash that companies with defined benefit pension plans must set aside to fulfill funding requirements. The low rate also inflates lump-sum distribution calculations, creating the appearance that more cash is needed to reach a promised benefit at retirement age.

The administration’s proposal gets to the heart of the issue surrounding what interest rate companies should use when deciding how much to sock away for their defined benefit pension plans, in place of the 30-year Treasury bond rate.    Under the new proposal, for the first two years, the contribution rate would be calculated from a new interest rate benchmark based on long-term conservative corporate bond rates, as proposed in reform legislation put forward by Representatives Benjamin Cardin (D-Maryland) and Rob Portman (R-Ohio) (See  Unfinished Business, Regulatory Relief Top Portman/Cardin Bill ).

After a two-year transition, however, the administration’s proposal goes off in another direction.   At that point, firms would have to start phasing in calculations that take into account when their pension bills would actually come due, using different points on the corporate bond yield curve. The phase-in would be complete by the fifth year.

It is the use of the administration’s as yet undefined yield curve that raises the most concerns about opening a Pandora’s box of volatility and complexity in valuing pension liabilities.    “I don’t think Congress is ready for the yield curve approach,” says ABC’s director of retirement policy John Scott. “I think plan sponsors should be concerned about these proposals.”  

Instead Scott points to some changes being suggested to the Bush proposal that would move away from the hard-line yield curve approach and blend more smoothly with earlier Portman-Cardin provisions of   high-quality corporate bond based interest rates.   “I don’t think it will be a yield curve approach, but somewhere in the middle, as a way of looking at different proposals,” he said.

Donald Segal, chief research actuary with the Segal Company, agrees that plan sponsors would be looking at a more complicated plate under the Bush proposals.   "It's going to add an administrative burden," because of complexities associated with such an idea, as well as the current lack of clarification and guidance offered by the administration's initial proposal.   "It's not clear if they are talking about an individual yield curve for everyone, and if that's what it means how can that be simple?"   Segal asks, further noting that with individual yield curves, "isn't that going to introduce human resources issues?"

One such issue is attempting to match companies' growth rate assumptions with their workforce demographics. Segal notes that companies that have older workforces would have to assume shorter-term, and therefore lower, growth rates. They would therefore face higher contribution requirements than companies with younger work forces.

Scott thinks that government officials may have been overly concerned about being seen as cutting businesses too much slack in calculating their pension-plan contributions - and that could come back to haunt the government. The administration had "more of an eye towards the government's perspective, particular the [Pension Benefit Guaranty Corporation] PBGC's perspective.   There is a lot of nervousness in the administration about large companies with large underfunded pension obligations," Scott said.

Pension plans that become insolvent usually wind up being taken over by the PBGC, which is funded by contributions from private sector employers whose defined benefit plans the agency insures as well as the agency's investment income. However, with the recent string of high profile plans going bust, Treasury officials are concerned that too many defaults may place the burden square on the shoulders of taxpayers.

To alleviate this potential quagmire, the administration's proposal includes a second tier of proposals that would require companies to disclose the value of the plan's assets and liabilities on a termination basis in annual report, in an attempt to make these plans more transparent.    By doing this, administration officials are trying to determine what liabilities the company would have if it were to terminate tomorrow.  

The administration has also proposed that certain financial data already collected by the PBGC from companies sponsoring pension plans with more than $50 million of underfunding should be made public, including the assets, liabilities and funding ratios of the underfunded plan, but not confidential employer financial information, according to the Treasury.

If a plan's funding ratio falls below 50% of its termination liability, benefit improvements would be prohibited, the plan would be frozen (no accruals resulting from additional service, age or salary growth), and lump sum payments would be prohibited unless the employer contributes cash or provides security to fully fund these added benefits, according to the administration's proposal.   Treasury notes that, in an analysis of over half of PBGC claims, 90% of companies whose pension plans have been trusteed by the PBGC had junk bond credit ratings for the entire ten year period before termination.

However, Scott says this idea may end up creating more contention with workers than it would help.   "Having to disclose assets and liabilities on a termination basis is not really done today because companies view these as ongoing entities, you might generate some ill will among employees," he said.

Congress too has its questions.    To help provide some clarity on the issues, the House Education & the Workforce Subcommittee will hold a hearing on the proposal on July 15, 2003.  "This hearing will provide the Congress with an opportunity to analyze the Administration's recently unveiled plan. Given the exigencies of this issue, I am hopeful the hearing will pave the way for swift legislative action," said Representative Jim McCrery (R-LA), Chairman, Subcommittee on Select Revenue Measures of the Committee on Ways and Means in a news release announcing the hearing.

A copy of the administration's proposals can be found at  http://www.treas.gov/press/releases/js529.htm .