Official Predicts Minimal Effects of Pension Reform on Markets

May 17, 2006 ( - Assistant Secretary Mark Warshawsky of the Treasury Department discussed the effects of pension funding and accounting reforms on equity values and interest rates in a speech at the European Institute's Sovereign Fund Roundtable.

In his  speech , Warshawsky pointed out that lawmakers are currently trying to reconcile the House and Senate bills relating to pension funding reform and that the Financial Accounting Standards Board has proposed accounting standards for pensions and other post-employment benefits. The Treasury official said that there are three key provisions for pension funding that the administration is pushing legislators to adopt in the compromise measure.

According to Warshawsky these three provisions are:

  • Pension funding targets would be based on near mark-to-market measures of pension assets and liabilities.  For purposes of calculating liabilities, discount rates would be gauged to duration in accordance with a high grade corporate bond yield curve computed and published by the Treasury Department.
  • All sources of underfunding would be amortized over seven years.
  • For purposes of determining maximum tax-deductible pension contributions, a cushion level of over-funding would be allowed.

In his discussion, Warshawsky said that the effect these changes in pension funding rules and proposed changes in pension accounting could have on financial markets would be due to the fact that the new rules could induce fund managers to move pension investments away from equity and into fixed income securities, especially bonds with long maturities and durations. The purpose, he said, would be to make fund returns more closely match future pension liabilities and to reduce volatility.

However, Warshawsky believes it would be highly unlikely that all or even most of the equity investments would be redirected to fixed income vehicles, since equities, over time, improve fund returns. He cited Committee on Investment of Employee Benefit Assets (CIEBA) surveys in 2003 and 2005 that suggest that the upper limit to the proportion of DB pension assets that would be redirected from equities to fixed income securities if there were pension funding and accounting reform would be about 20%.  At present private DB assets are a bit less than $1.8 trillion, so 20% of assets would come to $360 billion.

This number would be further reduced to $300 billion since the reforms are aimed at single-employer private pensions and not multi-employer or governmental plans, Warshawsky pointed out.   He estimated that, if the rebalancing were to occur over a two year span, it would amount to a temporary shift of less than 1% per year from the equity market to the fixed income market, and after a few years the rebalancing would be finished.

Warshawsky notes that markets should be able to absorb this small amount with no lasting effects.Similarly, he said, the new regulations would not have any sustained effects on interest rates. “Assuming that Treasuries are less than a third of the fixed income market, the resulting temporary effect would be a reduction of about 10 to 15 basis points in fixed income yields at the long end for a few years, after which the effect would be absorbed by markets,” Warshawsky said.

Warshawsky concluded that “any movements in financial markets brought about by pension reform are likely to be temporary, and small enough that they would not be disruptive or destabilizing.”