Don't let companies slash pension payments
Opinion: Congress has a soft spot for giving corporations a break because contributions are tax-deductible. But allwoing more underfunding hardly seems prudent.
By Roger Lowenstein, Bloomberg
There is something about pensions that makes their sponsors just want to say no. For months we have been reading about cities and states failing to pay what is due into employee pension funds. Now corporate America is getting into the act.
Big employers want Congress to give them a break on pension funding. Business lobbies such as the U.S. Chamber of Commerce and the National Association of Manufacturers have managed to get a pension sweetener attached to a Senate highway bill that, potentially, would reduce required contributions by billions of dollars.
This is the same sort of short-term thinking that got companies such as United Airlines, Bethlehem Steel Corp. and Delphi -- or, to be more exact, their workers -- in trouble. From the shelter of bankruptcy, these employers terminated their pension plans, leaving inadequate funds to pay retirees. The government-run Pension Benefit Guaranty Corp. pays $458 million every month to more than 800,000 retired workers of about 4,300 failed companies. In many cases, insurance didn't cover the full amount and workers got stiffed.
Last year, 152 additional failed plans were terminated and added to the PBGC's load. Among them: Harry & David and Wolverine Tube. We don't need to encourage a new crop of Harry & Davids. (The PBGC dodged a bullet last week when AMR Corp., the parent of the bankrupt American Airlines, agreed not to terminate at least three of its four employee plans.)
In the past, Congress has been an easy mark for pension sponsors seeking relief. In fact, Congress has eased the rules six times in the past decade, by the PBGC's count. This is one reason that, among the Standard & Poor's 500 companies, those that offer pensions were roughly $450 billion underfunded at year-end 2011, according to David Zion, the resident pension maven at Credit Suisse Group AG in New York.
That's the largest deficit in years. In 2002, after the recession that began the prior year, pension sponsors in the S&P fell to an estimated 82 percent of actuarial funding. They rebounded but then lost ground during the financial crisis, hitting 79 percent of required funding in 2008. Now, pension funding has crashed to only 74 percent, meaning that a quarter of the required assets aren't there.
The reason for the problem this year is ultra-low interest rates. Under the federal Employee Retirement Income Security Act, sponsors have to contribute enough to meet their future obligations and to make up any deficit in a timely fashion. Three numbers determine the level of contribution: the total plan assets, the amount that retired workers will be owed in the future and the "discount rate" at which that future obligation is discounted back to the present. (The discount rate is calculated by blending interest rates of bonds whose durations roughly match the schedule of pension payments.)
As the discount rate falls, the present value of payments soars. At General Electric Co., the discount rate fell to 4.2 percent at the end of 2011 from 5.3 percent at the end of 2010. According to GE, that added $7.4 billion to its pension obligation.
Zion estimates that pension contributions for all sponsors in the S&P 500 will rise by more than 70 percent in 2012, eating up a big share of available cash at some. At Weyerhaeuser Co., the pension contribution in 2012 will be more than 40 percent of trailing cash flow, calculated as the average of cash flow over the last five years, Zion says. At AK Steel Holding Corp. and Goodyear Tire & Rubber Co., contributions in 2012 will be well over half of trailing cash flow, he says. And contributions are likely to stay high. This is why companies want a break. Nonetheless, granting it would be a terrible idea, in Zion's phrase, merely "kicking the can down the road."
The provision in the Senate bill would keep the effective discount rate within 15 percent of its average over the past 10 years. Business groups are wrapping their argument in the flag, saying sponsors can use the extra cash to hire workers and make investments. But a business's first obligation is to the workers it has already hired. Pension expenses are not discretionary, and the amount owed in the present isn't a future expense; it is the current requirement to meet a future obligation.
Supporters of pension sponsors often say that, without relief, companies may stop offering benefits in the future, known as freezing their plans. This is no idle threat, as the population of private-sector workers covered by pensions has nosedived, to about 16 percent.
This is no reason, however, to ease up on requiring that ongoing plans be actuarially sound. If the economics of pensions become too onerous, freezing plans is an appropriate and realistic response. Workers are then free to negotiate other benefits, quit their jobs, or accept that life will get worse. Underfunding merely sustains the fiction that a plan is more viable than it is.
Sponsors also maintain that current interest rates are atypically low, resulting in unusually high payments. But interest rates are what they are -- not even Congress can change them. If rates do rise in the future, contributions then will drop; no legislation will be needed.
Most sponsors will see some relief, anyway, when recent stock market gains are reflected in their asset totals. And sponsors could have inoculated themselves against interest rate risk completely by investing plan assets in bonds of the same duration as their pension obligations.
Had they done so, their assets and obligations would have risen in lockstep. If, instead, sponsors took investing risk, why should Congress grant them a favor, which will make next year's problem worse? Also, with rates so low, you wonder why companies don't simply borrow the money.
Congress has a soft spot for the idea of giving corporations a break because pension contributions are tax-deductible. Thus, those that contribute less to their pension funds pay more in taxes. On that logic, companies might as well cut contributions to zero. But the PBGC already faces a $26 billion deficit, and the agency estimates it will incur as much as $250 billion in possible losses from underfunded sponsors in the future. Permitting more underfunding hardly seems prudent.
For too long, the pervasive mentality among retirement sponsors, both in the private and public sectors, has been that pension payments can always be put off. This would be true only if employees never aged. No one forced these companies to offer their workers pensions. For those that did, let 'em pay the actuarial rate.
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