Risk Management

Pension Windfall May Surprise Some CFOs

The method for calculating minimum annual contributions has changed in plan sponsors’ favor.
David McCannJanuary 30, 2013

Sponsors of defined-benefit plans may be able to dramatically lower their minimum required contributions, at least in the short term, under a provision buried in a mostly unrelated bill signed into law last July. The opportunity, however, may have escaped the attention of CFOs at some plan-sponsoring companies.

The Moving Ahead for Progress in the 21st Century Act (MAP-21), which provided $105 billion for improving the country’s surface-transportation infrastructure, also changed the basis for calculating plan sponsors’ minimum contributions for a particular year.

Before the law was passed, sponsors (or their independent actuaries) performing the annual valuation of a plan’s future liabilities and calculating minimum annual contributions were required to use a two-year rolling average of interest rates for AA-rated corporate bonds. That has been draining sponsors’ coffers. With the historically low interest rates in recent years having severely depressed pension plans’ investment income, the sponsors have had to greatly increase their contributions in order to meet the actuarially calculated minimum contributions.

But MAP-21 provides that instead of using average bond-interest rates over the previous two years, plan sponsors can use average rates over the previous 25 years to calculate minimum contributions. Were it not for the change, plan sponsors would have had to base the calculation on a rate of about 4.5% for 2012, according to Bobby Marks, executive vice president of Madison Pension Services, an actuarial firm. The change allowed them to base the calculation on a rate of about 7%, reflecting the much higher interest rates that prevailed for most of the 25-year period.

“So far, we have seen minimum required contributions for 2012 reduced by as much as 33%,” says Marks. And plans with healthy funding ratios (the plan’s assets expressed as a percentage of the plan’s future liabilities), such as 90%, might actually be able to avoid minimum contributions entirely for a few years, he adds.

Using the 25-year average interest rate was optional for 2012; starting with 2013 it will be mandatory. Many plan sponsors have already calculated their minimum required contributions for 2012 using the old method of establishing interest rates, but MAP-21 allows them to recalculate that minimum using the new, more favorable method. Contributions for 2012 plan years are not required to be made until September 15 of this year.

But some CFOs working for companies that sponsor traditional pension plans may not necessarily be aware of the potential windfall, says David Gensler, Madison’s president. “Actuaries know about it, but I don’t know that we’ve done a great job of reaching out to our clients, because we know it’s going to be mandatory for 2013 anyway. I’m not sure how many CFOs of plan sponsors realize that 2012 is a year for which you get a do-over. Most CFOs are hardly experts on pensions.”

What’s more, the pension provision was stuck without fanfare in the middle of a transportation-funding bill. There’s apparently no connection between pension funding and infrastructure funding, other than Congress’s usual desire to make funding bills as revenue-neutral as possible. In this case, the thinking seems to be that if companies reduce their pension obligations, their bottom lines will rise and they’ll pay more corporate income taxes.

The size of plan sponsors’ windfall will diminish during the next few years, though. For 2012, the interest rate used to calculate minimum calculations is actually 90% of the 7% 25-year average. Then the rate to be used will be 85% of the applicable 25-year average for 2013, 80% for 2014, 75% for 2015, and 70% for 2016 and thereafter. “The impact of MAP-21 will diminish,” says Marks.

And in the event interest rates finally recover to the point that the 25-year average isn’t higher than the 2-year average would have been, the impact of the law will turn negative for plan sponsors.

Further, it must be remembered that only the minimum contributions for particular years are affected, and not the total amount that must be contributed over time. “For a while you buy yourself higher interest rates and lower contributions, but ultimately the plan still owes what it owes,” says Gensler. “It’s kicking the can down the road. The hope is that down that road, the company will have grown and be in a stronger cash position.”