Human Capital & Careers

Ways and Means of Relieving Underfunded Pensions

Committee's recommendation to full House of Representatives may ''free up cash for other corporate uses.''
Stephen TaubJuly 21, 2003

On the heels of another report about underfunded pension funds, good news from Washington would be welcome — even at the expense of a little name-calling.

First, the report. Among companies that sponsor traditional defined benefit plans, deferred costs — defined as costs not yet reflected in the income statement — increased sharply in 2002, due to a steep drop in funding levels for the second straight year, according to a new Towers Perrin study.

Towers Perrin examined the annual financial statements of more than 300 major companies with pension plans, including 81 of the companies in the Fortune 100. According to the study, the level of deferred costs soared from an average of $770 million in 1999 to an average cost of nearly $1.4 billion at the end of 2002.

Furthermore, the average pension plan’s funded status at the end of 2002 had declined by more than one-third — from 120 percent to 77 percent — compared with three years ago. “This decline in funded status is largely attributable to the combination of negative asset returns along with a significant drop in interest rates,” according to Towers Perrin. The interest-rate cuts have caused decreases in the investment income available to fund pension liabilities.

“Companies sponsoring pension plans are unquestionably in a challenging financial environment,” said Steven Kerstein, managing director of Towers Perrin’s Global Retirement consulting practice, in a statement. Deferred pension cost “is only one of many aspects of plan management that need to be addressed.”

Indeed, CFO.com reported in April that the percentage of employers with fully funded plans plummeted from 84 percent in 1998 to 37 percent in 2002, according to Watson Wyatt. And according to the Pension Benefit Guaranty Corp., which oversees the pension industry, total pension underfunding exceeds $300 billion at U.S. companies.

Members of the House Ways and Means Committee may have had those numbers in mind on Friday, when they recommended a pension reform bill to the full U.S. House of Representatives. Passed amid “partisan acrimony” during which “Capitol police were summoned,” according to Reuters, the measure would provide three years of relief for companies while a permanent measure is sought.

Defined-benefit pension plans would be allowed to assume a more generous return on investments, based on an index of high-grade corporate bonds, Reuters reported, rather than rely on the current formula, which is based on the yield of 30-year U.S. Treasury bonds.

Shortly after the announcement of the measure’s passage, Standard and Poor’s released a statement that its estimate of pension underfunding for the S&P 500 is under review.

“If the House approves the proposed three-year use of the high-grade corporate bond rate, which is currently yielding 128 basis points higher than the 30-year Treasury,” stated the press release, “the amount of pension underfunding among U.S. companies would significantly decrease, resulting in lower corporate contributions to their pension funds.” Added the S&P statement, “This change would free up cash for other corporate uses.”