White House Throws Pensions A Curve

Steel, auto and airline companies were about to feel good about retiree drug benefits. Now this.

The U.S. Treasury Department introduced three proposals today designed to improve what many see as a looming corporate pension crisis. And it's no surprise that the administration's plan, unlike a current bipartisan bill in the House of Representatives, includes a proposal based on higher interest rates. Those higher rates are manifest--and almost guaranteed--due to expected government deficits.

Both the administration and House plans recommend moving the assumed discount rate for pension liabilities from the current benchmark of no-longer-issued 30-year Treasuries to a blend of corporate bond rates. And then the administration's proposal throws its curve, literally.

The Treasury said this morning that the bond-rates benchmark, currently yielding between 1 and 1.5 basis points above 30-years (now 4.78%) for top-tier investment grade bonds, should be phased out after two years and moved to a corporate bond yield-curve model. If that happens, pension fund managers will be subject not only to the government's moving long-term target but would, by law, be required to fund around a curve set by the spread between corporates and treasuries.

In a prepared statement, the Treasury said that the yield-curve model "provides the right level of contributions...based on an accurate determination of plan liability." But some in the industry disagree. "After two years, we'd be back into the morass of unknown possibilities," says Janice Gregory, vice president for the ERISA Industry Committee in Washington (ERIC), a trade association of some of the largest U.S. corporations affected by the Employee Retirement Income Security Act.

Kenneth Porter, director of global benefits for DuPont, told a Department of Labor advisory council on June 26 that "a yield curve would likely increase required contributions in plans with large numbers of retirees. This could cause very severe economic hardship for those companies." Read: steel, automotive and airlines, the three sectors outlined by Steven Kandarian, executive director of the Pension Benefit Guaranty Corporation, as being most at risk due to massive underfunding.

PBGC, a quasi-federal institution not backed by the full faith and credit of the government, insures and/or picks up terminated pension plans but often has to cut back on previous corporate promises. In April, Kandarian said PBGC is looking at $35 billion in vested underfunded claims in "reasonably possible" plans sponsored by financially weak companies. Those are liabilities that could fall to PBGC this year, following major steel plans and the US Airways Group pilots' plan that fell in its lap last year. Kandarian said that the airline industry currently is underfunded by $26 billion, while the automotive sector is $60 billion underfunded. That's more than a quarter of the $300 billion of total underfunding for defined benefit plans in the United States. And PBGC currently insures five times that, or $1.5 trillion, in benefits.

Major corporations have been crafting new ways to meet funding requirements. General Motors, underfunded by $19 billion, went straight to the bond market . IBM chose a $3 billion cash and stock contribution for its plan. Also hevily underfunded at the end of 2002 were SBC Communications and Boeing.

While such major industrial companies have been opening up regarding their pension liabilities and rate of return assumptions, there is still a worry that smaller funds with fewer beneficiaries are just as much at risk. In fact, PBGC has already collected the data but can't currently disclose it. The administration plan, then, requires companies with plans more than $50 million underfunded to make public their assets, liabilities and funding ratios.

The third major proposal by the administration would freeze a plan for companies with junk bond credit ratings and a funding ratio below 50% of the plan's termination liability. Such a clause is more beneficial, of course, to creditors and shareholders and pension insurers by prohibiting financially unstable corporations from adding to benefit plans without adding actual cash.

"What we are talking about here is cash," says ERIC's Gregory about both the House bill and the administration proposal. It's cash that employees are promised and shareholders covet. But neither should expect to be entirely satisfied any time soon. Just as the government is trying to fix Medicare with a giant bandage, many feel that without a true debate and overhaul of ERISA, the proposed pension solutions is just another patch.

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