The Senate passed a bill this week that would allow companies to use a 25-year average of corporate bond yields when calculating their defined-benefit pension liabilities. If the measure becomes law, it could greatly reduce the contributions companies have to make to their pension plans, but it’s not clear whether the House will adopt the Senate provision.
The Senate measure is contained in S. 1813, a transportation funding bill. Kathryn Ricard, senior vice president of retirement policy at the ERISA Industry Committee, which represents major U.S. employers, says that a bill to extend transportation funding that the House produced in February did not include the pension provision.
The current transportation funding measure expires on March 31. With Congress due for a two-week Easter recess, Ricard says the House may enact a temporary extension to transportation funding, or a longer extension that postpones deliberations until the lame duck session at the end of the year.
While the timing is unclear, she is optimistic about the chances for the pension measure to become law, noting that it is a revenue-raiser. (Pension contributions are tax-deductible, so lowering contributions means more taxable income and more tax revenue.)
“It helps pay for the transportation provision,” Ricard says. “There’s a lot of support to keep it in there.”
Under the Senate measure, companies would continue to value their liabilities using the discount rate set in the 2006 Pension Protection Act: a two-year average of the rate from the appropriate segment of the corporate yield curve. But for 2012, the rate they used would have to be within a 10% range of the 25-year average of rates for that segment.
At year-end 2011, the corporate discount rate was about 5.5%, says Andrew Wozniak, director of portfolio management and investment strategy at BNY Mellon Asset Management. The 25-year average for long-term AA bonds was 7.13%, he says, with the low end of the 10% corridor at 6.42% and the high end at 7.85%.
Since the 5.5% rate would be outside the 10% corridor, the Senate measure would have companies use the low end of the corridor, 6.42%, instead. The difference of about 100 basis points on the rate would mean a 10% to 15% decrease in plan liabilities, Wozniak says. “That would make the funding status higher, and therefore they wouldn’t have to put as much money in the [pension] trust.” He estimates aggregate corporate pension plan contributions this year could be cut by as much as two-thirds.
The Senate measure would increase the percentage that defines the corridor to 15% in 2013, and continue to boost it 5 percentage points a year until it hit 30% in 2016, where it would stay.
Applying 2016’s 30% to the 25-year average results in a low end of 4.99% and a high end of 9.27%, Wozniak notes, with the 5.5% discount rate falling within the corridor. “If the 2016 rules were here, sponsors wouldn’t get any relief,” he says.
If fact, if interest rates head significantly higher, the two-year average rate could end up above the high end of the corridor around the 25-year average, in which case plan sponsors would have to use that high-end rate to value their liabilities, Wozniak points out.
He also notes that the change would have no effect on what companies report on their balance sheet or income statement, “which is what many companies are more sensitive to.”
Corporate contributions to defined-benefit pension plans have been rising, reflecting the damage done to plan assets by the financial crisis and recession and the boost to plan liabilities that results from record low interest rates. A study published last fall by the Society of Actuaries showed that in the decade that ended in 2009, companies’ cash contributions to their plans averaged about $66 billion a year. The study estimates that minimum required contributions will average $90 billion a year in the decade that started in 2010 and hit a peak of about $140 billion in 2016.
Organizations representing corporate plan sponsors argue that companies deserve some relief from the impact of the Federal Reserve’s decision to keep rates so low.
“The actions by the Fed to control interest rates potentially put a significant near-term burden on sponsors of defined benefit pension plans, something that the Fed has acknowledged,” U.S. Steel CFO Gretchen Haggerty said in February in testimony to a House subcommittee. Haggerty said that capital investments U.S. Steel plans to make could suffer as a result of the pension funding demands, and if enough companies curtail capital spending to make pension contributions, “the economy will continue to disappoint and under perform.”