VideoIt is 2005 and the pension system is in crisis — again. Just as in the mid-1990s, Congress and columnists are warning of the imminent demise of the defined-benefit retirement plan. And again, thanks are due to the failure of a few companies — mostly in the airline industry — to meet their obligations. Back then it was TWA. Today, United Air Lines leads the roster of bad apples. But this time, the government seems determined to step in, and a revolution in how companies calculate their pension-funding obligations may be in the offing.
The government has three proposals on the table. One is from President Bush; another is wending its way through the U.S. House of Representatives. The business community is not happy with either, especially the President's. Corporate spokespeople contend that Bush's proposal to overhaul the pension system will backfire, and could force employers to freeze or terminate their current plans. A third option, already passed by the Senate Finance Committee, is closer to the Bush proposal than the House's, and gives the airlines 14 years to fully fund their pensions.
Both the Bush and the House proposals would require companies to fully fund their defined-benefit pension plans much sooner, raising the level to 100 percent from the current 95 percent. But by changing the methodologies for calculating plan funding, the proposals undermine the ability of CFOs to figure out their pension obligations in a given year. Both proposals also require firms with defined-benefit pensions to pay higher premiums to the federal Pension Benefit Guaranty Corp. (PBGC), the financially shaky agency that insures corporate plans. And they will institute these changes rapidly — by next year in many cases.
"CFOs I talk to tell me the reforms will be expensive. But what they are really concerned about is their ability to predict their fund contributions accurately, compromising their need to plan, budget, and tell Wall Street, 'Here's what we are spending on our pensions over the next few years and how much money we will have available for other things,'" says James Klein, president of the American Benefits Council, a Washington, D.C.-based employer advocacy group.
The Usual Suspects
Everyone agrees that the corporate plans are massively underfunded (through April, by an aggregate $354 billion). Moreover, employers are dropping their pensions as fast as they can. "The system is hanging by a thread," says Klein. "From 1994 to 2004, we went from 58,000 defined-benefit plans nationwide to 29,000, not counting the high number of plans that have been frozen to new hires."
But it is the default rate that is forcing the issue of reform. In the last three years, almost 600 companies have reneged on pension-fund obligations, with 21 totaling $100 million or more, topped by United's pension-fund failure at $9.8 billion, the biggest since the government began guaranteeing pensions in 1974. In June, Delta Air Lines and Northwest Airlines told Congress their plans would default unless legislators extended the funding deadline. The automakers, short by $55 billion to $60 billion, may not be far behind.
Such defaults have swelled the PBGC's deficit to $23.3 billion, a figure that is expected to balloon to $71 billion during the next decade, according to the Congressional Budget Office. To beef up the PBGC's resources, both the Bush Administration's pension reforms and the Pension Protection Act (HR 2830, co-sponsored by Rep. John Boehner (R-Ohio) and Rep. Bill Thomas (R-Calif.), chairman of the Ways & Means Committee) call for increasing the premiums paid to the PBGC from $19 per employee to $30 per employee in order to avoid a public bailout, says PBGC executive director Bradley Belt. "We need to change the rules to make sure companies honor their obligations," he comments.
Others argue that companies that default on their pensions should just face the consequences. Mark White, CFO of enterprise-software vendor SAP America, says there should be no accommodation for "companies that default, or threaten to default, on their pensions. I'm tired of companies that think they can blackmail the federal government," he explains. "If they need to default, they should just do it and get it over with."
No Smooth Sailing
Beyond funding the PBGC, three issues in the reforms are receiving the lion's share of the criticism: elimination of credit balances, use of a yield curve to measure pension liabilities, and the continued use of current pension-fund-smoothing techniques.
As heated accounting issues go, pension smoothing ranks right up there with stock-option expensing. According to current rules, companies are permitted to smooth fluctuations in the market value of plan assets by averaging this value over a five-year period. The average asset value may range from 80 percent to 120 percent of the plan assets' fair-market value. Bush's proposal would end this practice. In support of this position, the PBGC's Belt argues that smoothing "distorts an accurate portrayal of the financial condition of a pension plan, and should be banned."
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