Pension Reform Bill Likely to Prompt More DB Freezes

Moody’s Investors Service said in a news release about its report on potential impacts of the Pension Protection Act of 2006 that the new law is also likely to drive more plan sponsors to either freeze their defined benefit program or get out of it entirely.

Additionally, some employers may decide to move their investments away from equities towards fixed income instruments to better match their cash flow from their assets to benefit payments, Moody’s said.

Moody’s analysts also pointed out that companies with underfunded pensions will likely borrow to make up the difference starting in 2008 – a development which Moody’s said is not likely to affect their credit ratings. That is because the employers will, in effect, be swapping pension-related debt for contractual debt, the research company said.

“In certain circumstances, substitution of pension debt with contractual debt could reduce the cushion under existing covenants or require some firms to seek waivers to existing credit agreements,” said Moody’s managing director Gregory Jonas, in the news release “Also, we expect that lower rated companies will likely see increased pressure on coverage ratios given the likelihood of borrowing at higher interest cost to fund increased pension contributions.”

In general, Moody’s says the law’s 2008 effective date and numerous transition provisions should allow companies to prepare themselves adequately for any additional required funding.

Moody’s says companies with well-funded plans will not see a meaningful change in their required contributions. They could benefit from the ability under the law to put additional funds into plans in a tax-efficient way.

The report is “Pension Reform Will Increase Funding Requirements for Under-funded U.S. Pension Plans – Transition Provisions Will Allow Companies Time to Prepare.”