PBGC Warns of Deficit Reduction Contribution Suspension Impacts

November 11, 2003 (PLANSPONSOR.com) - The Pension Benefit Guaranty Corporation (PBGC) has raised a red flag about the potential downside to Congress waiving special rules designed to speed up cash contributions to severely underfunded pension plans.

The Senate bill, the National Employee Savings and Trust Equity Guarantee Act (NESTEG) sponsored by Finance Committee Chairman Charles Grassley (R-Iowa), would exempt companies from making deficit-reduction contributions to pension plans for a period of three years beginning after December 31, 2003 (See  Finance Committee Gives Grassley Pension Bill the Go-Ahead ).   Deficit-reduction contributions are made by companies when the market value of assets in their defined benefit plans drops below 80% of the current pension liability to current and future retirees. Accelerated ‘catch-up’ contributions then kick in to ensure that future obligations can ultimately be met.

However, the PBGC says ifCongress waives the special rules designed to speed up cash contributions to severely underfunded pension plans, the shortfall in these plans would grow by $40 billion over the next three years. “Giving a special break to weak companies with the worst-funded plans is a dangerous gamble,” said PBGC Executive Director Steven Kandarian in a news release (See  Steve Kandarian ). “The risk is that these plans will terminate down the road even more underfunded than they are today. If that happens, workers will lose promised benefits and the pension insurance program will suffer additional multibillion-dollar losses.”

Already, many of the companies that would benefit from the exemption pose a heightened risk of defaulting on their pension promises, the PBGC says.   Overall, the nation’s private pension insurer estimates the aggregate pension underfunding in plans sponsored by financially weak companies exceeded $80 billion as of December 31, 2002. Thus, the provision would allow companies representing nearly $60 billion of this “at risk” liability to stop making accelerated pension contributions. The average funding ratio of these plans on a termination basis is less than 60%, the PBGC adds.

Some Good?

On the other side, Fitch Ratings said in a research report that the bill would“help ease airline liquidity pressures” by delaying the deficit reduction contributions starting in 2005. Fitch estimated that the largest US air carriers collectively face an unfunded pension liability of more than $20 billion (See  Fitch: Pension Bills Could be Big Help for Airlines ).

This is due to a combination of poor market returns and declining interest rates over the past three years creating a situation in which plan asset values are well below the 80% funding threshold for airlines. As of year-end 2002, the pension plans of the six largest US network airlines (American, United, Delta, Northwest, Continental and US Airways) were all funded at less than 65% of the projected benefit obligation (PBO) – a common accounting measure of the pension liability (See   Fitch: Airlines’ Pension Picture ‘Most Dire”). Since the beginning of the year, however, the industry-funding gap has narrowed as a result of strong plan asset returns and an increase in interest rates from their historically low levels.

To this, the PBGC says that ultimately financially healthy companies with better-funded pension plans would also pay a price, since companies would pay for promised benefits under the weaker 1974 funding rules. Those rules allow companies to fund benefit increases over 30 years. By contrast, the deficit reduction contribution requires plan sponsors to pay off their unfunded liabilities over three to seven years – a faster schedule designed to get cash into pension plans before companies fail and transfer their liabilities to the PBGC.

  “If companies do not pay for their benefit obligations, someone else must,” Kandarian said. “In this case, other employers would face higher costs supporting the PBGC despite having adequately funded their own plans.”

With this, the PBGC says plan participants would lose because the law places limits on PBGC’s benefit guarantees. For example, the PBGC points to the case of Bethlehem Steel, where the PBGC is responsible for paying $3.9 billion of the plan’s $4.3 billion in unfunded liabilities, which means workers and retirees are losing $400 million in promised benefits. Also, the PBGC points to the US Airways’ Pilots Plan, where the PBGC will pay roughly $600 million of the $2.2 billion in unfunded liabilities, resulting in $1.6 billion of pilot losses.

  “Changes to the deficit reduction contribution could be a reasonable way to reduce contribution volatility, but they should only be pursued in the context of other reforms that strengthen long-term pension funding,” Kandarian said. “Abandoning the deficit reduction contribution without an effective substitute would put workers, retirees and other companies at risk.”