Employers that sponsor defined benefit (DB) pension plans have the potential to receive billions of dollars in temporary pension funding relief as a result of legislation signed into law on June 25, 2010, according to an analysis by consultancy Towers Watson. However, while the law may significantly ease financial pressures for some sponsors for at least two years, employers face potentially larger funding obligations after 2011.
Under the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act, employers with underfunded DB plans may elect to amortize funding shortfalls for any two plan years between 2008 and 2011 either:
• Over a 15-year period, or
• By making interest-only payments for two years followed by seven years of amortization.
Generally, DB sponsors are required to amortize shortfalls over seven years.
“The federal government has given employers the much-needed and welcome funding relief they were seeking,” said Mark Warshawsky, director of retirement research at Towers Watson. “Despite some improvement in the overall health of pension plans since the depths of the financial crisis, employers had been bracing for sharp increases in their DB funding obligations. Now, with the new law, employers can breathe a collective, albeit temporary, sigh of relief.”
The Towers Watson analysis projected funded status and minimum required contributions for single-employer DB plans under three scenarios for the five plan years from 2009 through 2013: the pre-act provisions, and the two funding options under the new pension relief law. It did not consider the impact of the law’s so-called cash-flow rules, which require extra pension contributions if executive compensation or dividend payments are too large, and could cause some employers to forgo the relief offered. The two funding options were tested for all potential two years of relief over the 2009-2011 period.
The analysis found that:
• Under the pre-act provisions, the minimum required contributions in aggregate would be $78.4 billion for plan year 2010, and would escalate to $131 billion for 2011 and approximately $159 billion for both 2012 and 2013.
• Under the new law, required contributions would be reduced between $19 billion and $63 billion, depending on which of the two provisions and which plan years employers choose:
1. The 15-year amortization for 2010 and 2011 funding shortfalls offers employers the maximum aggregate funding relief for employers over the 2009 through 2013 projection period, or
2. The seven-plus-two-year option for 2009 and 2010 funding shortfalls provides the least amount of relief.
The analysis noted that for employers with immediate cash-flow concerns, the seven-plus-two-year option for 2010 and 2011 may be the better choice to concentrate the relief, while the 15-year amortization rule spreads the relief more evenly over a longer period.
“The pension funding relief law significantly eases some of the financial pressures employers had been facing, at least for two years,” said Mike Archer, senior consultant at Towers Watson. “However, the choices that employers make now will have an impact on the magnitude of their future pension funding obligations. In addition, the new law’s cash-flow rule included in the legislation has the potential to make contribution requirements more volatile for companies that avail themselves of the relief.”
In a separate survey in July 2010 of 137 Towers Watson consultants on behalf of 367 employers, only one-quarter (25 percent) of DB plans were likely to elect the relief. Many employers had concerns about the application of the cash-flow rule and uncertainties around details of the new law; others were pursuing aggressive funding policies, had good funded positions or otherwise did not need relief.
For those likely to elect the relief, most employers intended to reflect it for plan years 2010 and 2011 and use the 15-year amortization option.
Excessive Focus on Pension Earnings Keeps Corporations from Cutting Pension Risk
In a separate report on DB pensions, consultancies Oliver Wyman and Mercer highlight the inhibitive impact of short-term U.S. corporate pension earnings on effective longer-term risk management. The joint report, Funny Money: The Increasing Irrelevance of Pensions Earnings, describes how current U.S. pension accounting standards cloud true economics by including a “funny money” component in pension earnings, presenting a fundamental obstacle to CFOs in pursuing rational risk management. The report estimates that this earnings component amounts to approximately $18 billion, or 4 percent of reported earnings at S&P 500 companies.
The authors argue that reported pension earnings are becoming increasingly irrelevant, as the underlying economics become more transparent. Proposed amendments to international accounting standards would remove the offending component of pension earnings by 2013, and the U.S. Securities and Exchange Commission (SEC) has indicated that convergence in U.S. and International GAAP standards may occur sometime around 2015.
“We see a growing number of U.S. corporations announcing an intention to reduce the impact of defined benefit pension volatility on their balance sheets,” said Mick Moloney, senior partner and head of Mercer’s financial strategy. “We believe evolving accounting standards will hasten the need for others to adopt similar approaches to better manage market perception of their plans, similar to a trend we have seen in Europe.”
The report details that while there are many and complex factors to consider in devising a pension risk reduction strategy, options available to corporations have also expanded—ranging from dynamic asset allocation to insurer buy-out. “Due in part to current favorable conditions in the life insurance market and the strategic options available to them, we believe that companies willing to quickly undertake a thorough diagnostic followed by the enactment of a plan for pension risk reduction may be able to create substantial shareholder value in the long term,” said Ramy Tadros, partner and head of Oliver Wyman’s North America insurance practice.
Stephen Miller is an online editor/manager for SHRM.
President Signs Pension Funding Relief into Law, SHRM Online Benefits Discipline, June 2010
Market Volatility Leads to Broader View of Pension Risks, SHRM Online Benefits Discipline, March 2010
Liability-Driven Investing Strategies Proved Worth, SHRM Online Benefits Discipline, February 2009
SHRM Online Benefits Discipline
SHRM Online Health Care Reform web page