While mounting pension obligations have become a thorn in corporate America's side, a new bill proposed by Congress could offer some relief. But not everyone is celebrating: Some say the bill ultimately could end up hurting employees.
As pension surpluses from the late 1990s have been transformed into deficits after a three-year bear market, a slew of companies have warned that they need to set aside hundreds of millions of dollars to shore up their pension plans. And Congress has taken notice. Last week, Democrat Benjamin Cardin of Maryland and Republican Rob Portman of Ohio introduced a bill to lower the amount that companies have to contribute to their postretirement plans.
Politicians and other proponents of the bill argue that falling interest rates have exaggerated pension liabilities on company balance sheets. In fact, they contend that the 30-year Treasury, which is used to calculate the present value of future pension liabilities, is artificially low, because issuance of the long bond was discontinued by the government in 2001.
The interest rate has an inverse relationship to pension liabilities, so the lower the rate, the higher the present value of future pension obligations.
For example, let's say company XYZ has to pay an employee $20,000 per year in 20 years. If interest rates are very low, at say 2%, the firm would need $13,459 today to cover the expense. But if rates were higher, at say 8%, the firm would need just $4,290 to cover.
Congress passed a stopgap measure in March 2002 that increased the range of permissible interest rates for calculating pension obligations, but that measure is due to expire at the end of 2003.
The new proposal aims to tie pension liabilities to high-quality corporate bonds -- which typically hold higher interest rates. The higher rate means pension liabilities would be reduced, and companies wouldn't have to contribute as much money to their plans.
"I think this is a great idea," said Bob Shepler, director of federal affairs at Financial Executives International, a nonprofit association representing financial officers of public and private companies. "The current rate is broken and needs to be fixed."
Indeed, this is good news for companies like
, which added $800 million in cash and stock to its pension plan last year and said it might have to contribute another $900 million in 2003. Pension expenses are expected to cut the firm's earnings by 36 cents a share this year.
pension contribution in 2002 was $4.9 billion, and the firm has said its pension costs would triple in 2003, seriously undermining its profitability.
UBS Warburg estimates that the new bill could reduce pension obligations by 10% to 20%, while ERISA Industry Committee, an industry association representing corporate America, has said it would cut required cash funding "in the hundreds of millions of dollars for many large companies." That would free up more cash for companies to make capital investments or pay down debt.
Still, some experts aren't convinced that it's a good idea to change the way pension benefits are calculated.
"These very low interest rates do inflate the liability measure, but pension plans aren't earning enough money anyway right now, so this may very well be a time that companies should be contributing more," said Julia Grant, professor of accounting at Weatherhead School of Management.
During the height of the bull market, investing pension assets in the stock market proved to be a successful strategy. As prices soared, gains from pension plans almost equated to another revenue stream. But as the market crumbled, many firms found themselves with less money in their coffers than was required by federal funding guidelines. While companies have started to contribute more cash to their pension plans recently, many firms continue to estimate high rates of return on their pension assets. An accounting quirk lets companies book gains on the basis of assumed rates of return, not the actual rate, and as a result, firms have been reluctant to reduce their estimates despite a more muted outlook for the stock market going forward.
Grant says the new bill is "shortsighted" because it addresses today's market conditions without addressing tomorrow's. "If everything turns around five years from now and rates go up, are we going to hear from ERISA saying that we should go back to the Treasury rate?" she said.
Jim Davis, a partner at law firm Gunster Yoakley in Florida, also pointed out that the proposal might actually hurt employees. That's because the 30-year Treasury is also used to calculate lump-sum benefits, which workers sometimes choose instead of a lifetime stream of income, known as an annuity. When interest rates are low, the lump-sum payouts increase, but when rates rise, lump-sum payments decline. "If people do take a lump sum, it will mean they get less cash," he said.
Still, Shepler believes lump-sum distributions are currently inflated, and he noted that there is a seven-year phase-in period, "so people expecting to retire within the next few years wouldn't be adversely affected."
George Bostick, a partner at Sutherland Asbill & Brennan law firm, concedes that some employees would be hurt by the new proposal, but he suggests that the move is ultimately in the best interests of everyone.
"As it is, employers are reluctant to continue their defined benefit pension plans or crank out new ones because of problems with funding," he said. "So to the extent that this sort of change makes defined benefit plans more attractive to employers, I think it does benefit employees."