Mixed Reform for Corporate DB Plans | Chief Investment Officer

Congress has passed a reform package for corporate pension plans, simultaneously easing funding requirements and raising premiums owed to the Pension Benefit Guaranty Corporation.

(June 29, 2012) — Congress has relaxed funding requirements for corporate defined benefit (DB) plans while at the same time raising the premiums they owe to the Pension Benefit Guaranty Corporation (PBGC).

The pension funding relief, passed as part of a omnibus bill dealing with highway funding and student interest rates, would lower contribution requirements for corporate DB plans over the next few years. Instead of the current rules, in which the discount rate used to calculate liabilities is based on a 24-month average of corporate bond rates, corporate DB plans will now be able to employ a rate based on a slightly modified 25-year average of corporate bond yields. Such a move will grant corporations some breathing room in which they can forgo sizeable pension contributions that the old rules would have mandated.

Corporate plan sponsors and pension experts, most prominently former PBGC director Charles Millard, have advocated for such a change because low interest rates have greatly inflated plan liabilities. The funding requirements stipulated by the 2006 Pension Protection Act, they argue, are too strict for today’s tough market environment and very low interest rates.

At the same time, the reform has jacked up the premiums that corporate DB plans owe to the PBGC. Premiums will rise by about 20% in 2013, and then an additional 16% in 2014. The extra premium that underfunded plans pay, known as the variable-rate premium, is set to rise as well. The added revenue, however, will not be used to shore up the finances of the PBGC, which is laboring under a $26 billion deficit. Instead, the money will be used to cover the cost of the extension of subsidizing student loans that is also part of the bill.

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An analysis of the bill by of Michael A. Moran of Goldman Sachs Asset Management contends that the relief to pensions will be short-lived. Given the vagaries of the new accounting standards, by 2016 the discount rate under the new rules could be indistinguishable from the discount rate currently in place. Warns Moran, “future mandatory contributions requirements may be even larger than under the current rules.”

(June 29, 2012) — The widespread belief that infrastructure offers a good inflation hedge may be a popular misconception, an article published in the summer issue of the Journal of Alternative Investments asserts.

“Infrastructure overall as well as its subsectors telecommunication, transport, and utilities hedge inflation neither particularly well nor any better than equities,” write Maximilian Rödel and Cristoph Rothballer of the Technische Universität München, Germany. “Only portfolios of infrastructure firms with high pricing power exhibit a slightly superior (yet not statistically significant) hedging quality at a five-year investment horizon.”

The German academics analyzed literature on the subject and conducted their own empirical study, which they said was the first to be done in a “comprehensive and methodologically robust” way. By and large, they conclude, infrastructure provides the same (inadequate) inflation hedge as equities. Only carefully selected infrastructure assets with strong pricing power give a somewhat credible hedge against inflation. Consequently, investors should “depart from the belief that infrastructure generally provides a natural hedge,” Rödel and Rothballer contend.

Large institutional investors, particularly pension funds, have gravitated toward infrastructure investments because they generate strong and stable cash flows. Part of their allure, however, has been their supposed hedge against inflation. While inflationary pressures are low despite rock-bottom interest rates, concerns persist about inflation in the medium-term. The conclusion of the academics’ article may spark a reexamination of the alternative investment as a result.

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To read “Infrastructure as Hedge against Inflation—Fact or Fantasy?” by Maximilian Rödel and Cristoph Rothballer, click here.