Changing: Pension Formula Rules

August 22, 2003
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GRAND RAPIDS — Treasury bond rates or corporate bond yields?

The choice matters to corporations, unions and employees — especially those workers closest to retirement.

A proposal made by the Bush administration in July to change how companies gauge their defined pension liabilities has drawn interest from all sectors of the labor market.

The plan put forward by the administration would allow corporations and unions to calculate their future contributions based on a corporate bond index instead of long-term Treasury rates, the current formula in use.

Treasury rates are lower than the corporate index and that means companies and unions are required to set aside more money to meet future demands of their pension funds. But switching to the corporate bond rate as the benchmark would raise the interest figure and lower future pension contributions.

Companies favor the change.

“Employers won’t have to have as much money in the fund and they say they can use it for more productive means, which means they can keep their businesses going, which means they don’t get into bankruptcy situations, in which case employees don’t get any pension or a very diminished amount of their pension,” said Keith Brodie, an associate with Dickinson Wright PLLC.

A few unions have chimed in and support a switch from low-interest Treasury rates, most notably the 30-year bond that is no longer offered.

“The current system is broken. We need a replacement, and we need it soon,” said Shaun O’Brien, assistant director of public policy for the AFL-CIO, to the Washington Post.

Employee groups, however, don’t support a switch. They feel the change will give companies a green light to underfund plans.

“Employees are looking at it and saying, ‘What this means is there isn’t going to be as much of a guaranteed bang for my buck in my pension plan downstream,’” Brodie explained.

“They look at that as a bad thing, obviously,” Brodie explained, “because if companies go under, or start to wind up, and if they have to wind up their pension plans, there is not as much money there.”

Under the president’s plan, all companies would estimate their pension contributions by using the same long-term corporate bond rate for two years.

But for the next three years, firms would change to a more complex corporate bond yield curve, which would plot the yields of bonds at different maturities.

Companies with a larger number of older workers and retirees would have to use shorter-term, lower-yielding corporate bonds to figure their contributions. Doing that would mean these firms would face greater liabilities and higher contributions than companies with a younger work force.

According to a report that aired on National Public Radio, the concern of workers who plan to retire in, say, 10 years is that their pensions could be funded at a lower level over the next decade than those funded during the past decade if a rate change is made.

For those who will retire in 2013, an estimate said they could find their pensions reduced by as much as 40 percent.

But results from a study released by Deloitte & Touche in January revealed that roughly 40 percent of mid-sized and large companies expect their pension expenses to jump by more than 50 percent this calendar year. Another 36 percent reported they were anticipating a rise of 11 percent.

The increase in pension cost, of course, is directly related to the drop the equity market has had, and many corporations are looking for new methods to fund the defined employee benefit.

And the drop in the equity market has forced some older workers to continue to work, rather than retire or take an early-out. Just in the past year, workers aged 55 to 64 have increased their participation in the work force by 2 percent.

Some of the nation’s biggest corporations that employ the largest number of blue-collar workers, such as the automakers and airlines, have expressed support for what may be the thickest pension reform bill ever.

Introduced by Reps. Rob Portman, R-Ohio, and Benjamin Cardin, D-Md., the bill contains 90 provisions in its 211 pages.

It favors using the higher yield of the corporate bond index, which the Pension Benefit Guaranty Corp. (PBGC) estimated would reduce future liabilities of almost every company by 10 percent to 15 percent.

But the provision most favored by firms with the greatest number of blue-collar workers is the one that directs the U.S. Treasury to consider mortality rates when determining how much a company must contribute to its pension fund each year.

Why? Because actuarial tables show that blue-collar workers don’t live as long as white-collar employees do, and this change could save a major blue-collar employer, like General Motors, another 4 percent in annual pension costs.

As for the administration’s plan, Portman and Cardin said they will give it a fair hearing.

“I don’t want to say we ought to accept their proposal verbatim, but I think we ought to look at it,” said Portman.

In the meantime, the PBGC, the government agency that insures pensions, has estimated defined pensions are currently underfunded by $300 billion. That figure compares to the $23 billion shortfall that existed in 1999 before the equity markets nose-dived.

According to a Wilshire Associates study released in May, the nation’s largest companies deposited $41 billion more into their pension funds last year.

Some have said the Portman-Cardin bill would save corporations across all industries between $30 billion to $60 billion in required pension funding each year.

“That heavy burden on the companies is forcing many to rethink their pension plans,” said Portman. “We want to make sure these pensions continue to be offered.”

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