Low interest rates have placed many named fiduciaries of defined-benefit plans in a particularly uncomfortable position. Poor investment performance has taken a toll on funding levels for pension plans, but harsh business conditions are making it difficult for companies to make the contributions necessary to shore up the ability of plans to meet future obligations.
Employees owe allegiance to their employer, but when they serve as fiduciaries to their company's pension plan, they are obligated to serve the exclusive best interests of plan participants and beneficiaries. This means they must make decisions that will serve to assure that promised benefits can and will be paid when due.
Unfortunately, what's best for plan participants often isn't in the best interests of the company. When business conditions are difficult, companies seek to conserve cash and protect corporate earnings.
Pension plan contributions can be seen as being at odds with these corporate objectives. The problem is magnified when rates are low because the discount rate used to calculate the present value of future benefits tracks bond interest rates: The lower the discount rate, the higher the pension liability that must be funded.
The discount rate is near historic lows, which in turn means that required contributions are reaching historic highs.
LIKELY TO WORSEN
The pension-funding problems created by low interest rates are acute and destined to get worse.
According to research by Milliman Inc., an independent actuarial and consulting firm, declining discount rates resulted in a record year-end pension-funding deficit in 2011 of almost $327 million for the 100 large defined-benefit plans the company has been tracking for the past 13 years. The declining rates also resulted in record charges against corporate earnings as pension expenses climbed.
The funded ratio (plan assets divided by projected benefit obligations) fell from a high of 122.7% in 2000 to just 79.2% at the end of 2011. Milliman expects all of these statistics to continue to deteriorate in 2012 since the
Federal Reserve plans to keep interest rates low through 2014.
Milliman suspects that companies have been modifying their methodologies of calculating discount rates to lessen the fall in rates. Moreover, companies have not reduced their expected portfolio returns for their plans as much as market conditions may warrant.
A “pension-funding stabilization” provision in a highway-funding bill before a House-Senate conference committee would replace assumptions about short-term interest rates with a much longer historical average for purposes of setting the discount rate for pension-funding calculations. This would dramatically lower the present-value calculations of pension liabilities and reduce contribution requirements.
The title of the provision is misleading because this procedural change would help stabilize company contribution requirements only at an overall lower level and make the pension-funding situation look better by assuming a rosier interest rate outlook. Lower contribution rates help plan sponsor companies but hurt the retirement outlook for current plan participants.
MISSIVE TO CONGRESS
More than 200 companies have signed an open letter to the members of Congress, supporting this change and advocating for more-expansive relief for companies that sponsor retirement plans.
The lead paragraph captures valid arguments from the corporate perspective: “Without legislation to adjust for current economic conditions, the current plan-funding regime will undermine job retention and growth, and limit companies' ability to invest in capital improvements needed to be competitive worldwide and to maintain the economic recovery here at home. Moreover, failure to address ongoing funding issues will threaten the long-term retirement security of workers and retirees.”
At the theoretical extreme, the corporate perspective expressed in the letter to Congress could be true. An equally defensible participant perspective at the opposite extreme would be that it is irresponsible to weaken already damaged pension-funding levels further.
There is a lot riding on the quality of the decisions made by both corporate officers and plan fiduciaries and their appreciation for one another's responsibilities. Serving in both capacities brings great awareness but requires extraordinary role clarity.
Blaine F. Aikin is chief executive of fi360 Inc. and a member of the steering committee for The Committee for the Fiduciary Standard.
