The ABC further says in its report that policymakers should be concerned that reforms that are passed could cause employers to give up on defined benefit pension plans entirely. The ABC notes that current law discourages overfunding of defined contribution benefit plans during good economic times which causes unpredictable funding requirements during economic down times. A recent survey by PriceWaterhouseCoopers found that the number one concern of companies who have terminated their DB plans or are considering termination is expense and funding volatility (See Expense and Funding Volatility Lead Co.’s to Ax Pension Plans ).
The PBGC posted a record deficit in 2004 of $23.3 billion (See PBGC Posts Record Deficit in FY2004 ). In its report, the ABC claims the high deficit number is a result of using an unreasonably low rate of interest for the PBGC’s calculation. The ABC says the interest rate the PBGC used to make its estimate (4.8%) is below the rate typically used by plans to calculate their funded status and points out that it is also below the “yield-curve” rate proposed by the Bush Administration in its pension reform bill (See Latest GOP Pension Reform Bill Includes Advice: Bill Provisions ).
Using the “yield-curve” – a measure of how interest rates change with respect to maturity obligations – the ABC calculated the PBGC’s deficit at $18.4 billion. The ABC’s estimate was further reduced when it used a weighted average rate based on high quality, investment-grade corporate bonds ($14.3 billion) and when it used a rate of 7.5% (which it noted was lower than what the PBGC has earned in recent years). That estimate put the deficit at $4.6 billion.
The ABC said that no matter what the deficit, the PBGC is in no imminent danger of solvency. Further, it said in the report that “The vast majority of the 34 million workers and retirees who are covered by single employer defined benefit pension plans need not worry about the security of their benefits because they participate in well-funded plans and there is no serious threat of default.” According to the ABC, in the PBGC’s history, more than 165,000 defined benefit plans were terminated with assets sufficient to meet liabilities.
The PBGC’s investment strategies also contribute to its problems, according to the ABC. Its investment strategy “is overly conservative and heavily skewed toward fixed-income securities,” the report said. The law requires the PBGC to invest the premiums in receives in Treasury securities. The ABC points out that pension benefits are paid out over many years warranting a less conservative investment strategy. It also points out that the belief that individual’s should be able to reap the benefits of higher returns from equity investments is one reason behind the Bush Administration’s proposal to privatize social security.
In the report, the ABC says the consequences of overstating pension plans’ liabilities and deficits include:
- Reducing the benefits workers receive, threatening their retirement security, when the PBGC takes over an underfunded plan,
- Adversely affecting the credit rating of the plan sponsor and increasing the risk of insolvency,
- Triggering an increase in plan contribution rates or PBGC premiums, thereby increasing the likelihood of sponsors to terminate their pension plans, and
- Causing lump sum distributions to be overvalued relative to annuities, causing retirees to select the lump sum option which decreases plan assets and contributes to underfunding.
In the report, the ABC suggests legislative changes are the answer to a more encouraging outlook for defined benefit pension plans. A reasonable interest rate would not overstate a plan’s liabilities and would reduce funding volatility. Allowing employers to build up funding during economic good times would further reduce funding unpredictability and volatility.
Additionally, the ABC suggests legislation to remove the PBGC’s investment restriction and to relieve uncertainty about the legality of hybrid pension plans such as cash balance plans.
“Giving employers incentives to enter and stay in the defined benefit system would be a giant step forward in securing the retirement income of a substantial portion of American workers,” the ABC said.
The report is here .