Rating Underfunded Pensions

To the ever-expanding list of pension headaches, add this one: credit ratings.

The Pension Protection Act of 2006, an almost 1,000-page bill that President Bush signed into law in August, sets a funding target of 100 percent for defined-benefit pension plans. It also requires companies to make increasingly large contributions to their pension programs if their balances fall below the required level.

Those potential payments have caught the eye of credit analysts, who are already scrambling to decide how to factor unanticipated cash outlays into corporate credit ratings. A report released by Standard & Poor's states that employers that retain a defined-benefit pension program will be subject to special scrutiny. According to the report, "The implications for [plan] sponsors will vary widely, and be fact- and plan-specific. It is impossible to discern potential trends from information currently available in financial reports."

"If you're a healthy company," says S&P managing director and chief accountant Neri Bukspan, the new rules "may put a little strain on your cash flow." Bukspan doesn't think the requirements will be crippling for any companies. But, he says, "if you're an unhealthy company, they will not help you maintain your rating and in many cases may weaken the rating."

A comparable report from Moody's Investors Service noted that while it does not expect any ratings surprises, the firm "expects to have discussions with our rated issuers to better understand their funding plans."

Credit-rating scrutiny is understandable, considering the sweeping nature of the law. The act changes smoothing of interest rates to two years for both assets and liabilities (down from five and four years, respectively), creating uncertainty regarding the year-to-year cost of funding retirement plans. In addition, the new funding requirements will cause many CFOs to consider "liability-driven" investment strategies, predicts Dale Wallis, CFO of Aerospace Corp., meaning they will opt for more-cautious investments, accepting lower returns in order to avoid unexpected shortfalls.

For companies with significantly underfunded pensions, one option may be to switch to a cash-balance program rather than try to make up the difference under the law's expedited schedule. (Most companies must comply with the provisions relevant to defined-benefit plans by 2008.) The new reform act will give cash-balance plans a legal boost by declaring them permissible under the law, which could short-circuit lawsuits that have challenged the legitimacy of such plans. The law also helps 401(k) sponsors by giving them more leeway to offer investment advice to participants.

Still, the credit-rating issue may be one more reason companies opt to bail out of the pension business altogether. "Funding reform will expose the inherent volatility of defined-benefit plans," says Rohit Mathur, one of the authors of the Moody's report. — Rob Garver

Dropping Out
Companies that have scaled back their DB plans since pension legislation passed in August.

1. DuPont
DB plan closed to new employees on January 1; pension contribution reduced to one-third of current level

2. Tenneco
DB plan frozen as of January 1; company expects to save $11 million annually

3. Blount International
DB plan frozen as of January 1; company expects to save between $16 million and $23 million over next five years

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Take It from the Top

Private-equity firms are getting more involved in the health-care game, and not just from the acquisition side. To cut costs, they're buying health-care plans for their portfolio companies.

The Riverside Co., a private-equity firm with three funds totaling $1.3 billion, is rolling out a plan to the majority of its 51 companies. The plan, offered by United Healthcare Services, the first insurer to provide health coverage specifically for private-equity firms, allows Riverside's companies to cut costs by aggregating their employees. Other private-equity firms purchasing health care for their respective portfolio companies include The Carlyle Group and Baird Capital Partners.

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