Mixed Reform for Corporate DB Plans

(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.

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.”