By James Moore
July 12, 2012
- The primary pension-related change in the legislation is to give temporary funding relief by altering the discount rate used for liability valuation and represents the third such change in the past decade.
- The estimated revenue impact from lower minimum required contributions seems optimistic to us, and misses some fairly obvious costs.
- Congress essentially extended a welfare transfer from the Haves to the Have Nots. Healthy plans may not bear the same increased cost per participant as weaker ones, but when you look at it per dollar of exposure to the PBGC, the Haves are paying far more.
- We have reached a point where it is time to redesign ERISA’s governance of defined benefit pension plans, starting with a clean sheet of paper.
“Who really reads this stuff?“ I found myself asking repeatedly in the
last few weeks. By “this stuff” I was referring to S. 1813, the “Moving
Ahead for Progress in the 21st Century Act,” or “MAP-21,” which
contained the Senate’s proposal for Pension Funding Stabilization.
I must admit that I didn’t read through all 1,676 pages, nor did I read all 91 pages of the Conference Committee “summary” report, but I did come to realize that I have unwittingly been paying a LUST Excise Tax to fund the LUST Trust Fund for decades. You, dear reader, probably have been too – 0.1 cent per gallon at every fill up. Before you reach the conspiratorial conclusion that the federal government is taxing us for our thoughts of the cardinal sin variety as well as our acts of the venial variety, know that LUST stands for Leaking Underground Storage Tank. It appears the Senate committee staffers who draft the legislation do not take a backseat to the armies of investment banking associates who created acronyms for structured products over the years.
Why changes to the ERISA rules on pension funding are attached to transportation legislation or why they count as a revenue offset to expenses incurred for highway expenditures could be fodder for an advanced civics course. One that goes way beyond the class I largely slept through in high school. It definitely goes way beyond my formative training in legislative process: singing along to “I’m Just a Bill” with a Pop-Tart and glass of milk during the Saturday mornings of my youth.
The primary pension-related change in the legislation is to give temporary funding relief by altering the discount rate used for liability valuation. Truly understanding the mechanics of the change and its implications requires a spreadsheet and a fair bit of squinting. Suffice it to say, it amounts to a complicated Mulligan that sets an interest rate corridor based on the past 25-year average of the corporate yields used for liability discounting. The current law allows for a much shorter two-year look back. Depending on the path of future corporate bond yields, the relief would fade sometime between 2014 and 2017 – the longer rates stay low, the longer the funding relief. Ultimately the discount rates would revert to current law.
This is the third time in a little over a decade that Congress has acted to amend discount rates to provide funding relief. Prior to 2002, the maximum discount rate allowable was 105% of a four-year weighted average of 30-year Treasury yields. The applicable percentage was raised to 120% as the then 30-year Treasury yield, 5.5% in December 2001, was “artificially low” due to the Treasury’s buyback program. As part of the Pension Protection Act (PPA) of 2006, the applicable discount rates were moved to A-AAA corporate rates as despite a return of 30-year Treasuries issuance, yields continued to march steadily lower. For comparison, the table below gives current estimated discount rates applying the four different approaches as well as discount rates applicable under the FAS 87, the relevant standard for pension accounting purposes.
The budget scoring for the conference version of MAP-21 relies on estimates of contributions. In theory, lower contributions mean fewer tax deductions means higher revenue. Two problems:
- A number of the Haves will make contributions in excess of the
minimum. There is a wide spread between the minimum required and the
maximum deductible contribution, and it is quite likely a number of the
profitable Haves will make contributions well in excess of the new
- If the economy continues to be anemic, or gets worse, a number of the Have Nots will be required to make the minimum contributions in years where they are not profit-making entities and would not be paying corporate income taxes regardless of what the minimum required contribution is.
In our experience, for many large, publicly traded pension plan
sponsors accounting has a larger impact on actual contribution and asset
allocation decisions than the minimum contribution rules. The pension
accounting presented in annual 10Ks is much more timely and transparent
to shareholders, bondholders, ratings agencies, and the financial press
than the 5500 forms filed with the IRS. Reduced contributions translate
to larger accounting funding deficiencies and reduced earnings on a
forward-looking basis as plan sponsors cannot earn returns on assets
that aren’t in the pension trusts. Many sponsors would prefer to make
larger, more predictable and steady payments that exceed the required
minimum contribution rather than make lower current payments only to
face the steeply rising contributions that the new rules would impose.
For those plans that were singed but healed and emerged more cautious
from their 2008-2009 experience and are looking ahead to a wall of
economic uncertainty, paying a bit more now when you have a known profit
and tax deduction outweighs the benefit of a reduced current cash
contribution but certainly greater payments in the future.
We doubt that the Congressional Budget Office budget scoring makes much if any allowance for contributions in excess of the minimum. Also somewhat curious is the mechanism by which additional Pension Benefit Guaranty Corp. (PBGC) premium payments are scored as additional revenue, but not an expense. Lower contributions, particularly among those plans that present the most risk to the system, justify increased insurance premia. But a normal insurer would also post correspondingly higher claims reserves, reflecting the higher risk of the insurance it is underwriting – in other words, higher revenues, but an associated higher cost.
Also curious is how the PBGC premia were raised. PBGC premia have two components – a per-participant charge and a variable-rate premia assessed on unfunded vested liabilities. Congress raised per-head costs from $30 to $42 in 2013 and $49 in 2014. The variable-rate premium of 90 basis points on unfunded liabilities is also scheduled to rise over time to 140 basis points, but will be subject to a $400 per participant cap regardless of total funding shortfalls. For comparison, note the cost of protection on the 10-year Investment Grade CDS index is currently 150 basis points. If you look at the debt spreads of those companies that present substantial risk to the PBGC, they are almost invariably higher than that level. Congress essentially extended a welfare transfer from the Haves to the Have Nots. Healthy plans may not bear the same increased cost per participant as weaker ones, but when you look at it per dollar of exposure to the PBGC, the Haves are paying far more.
After nearly four decades, the accumulated patchwork of Band-Aids and workarounds applied to ERISA’s governance of defined benefit pension plans is the worse for wear. We need a regulatory structure that i) provides benefit security for participants, ii) maintains the integrity of the system, AND iii) provides some measure of temporary relief to good, fundamentally solid sponsors that are experiencing short-term difficulties. As with the tax code, we have reached a point where it is time for a redesign starting with a clean sheet of paper. A redesign that does not pretend to solve other unrelated problems. Plan participants, corporate plan sponsors, taxpayers, and future generations deserve better. Whether or not they have lust in their heart.