Pension Reform Law Piles On The Disclosures

Companies intending to stick with their defined-benefit retirement plans now face increased cost and increased volatility, following the passage of a comprehensive pension reform measure in Congress that compels companies to ensure that pension plans are more fully funded.

For better or worse, however, business advocates say the overall impact of the new pension law will diminish over time—as more and more companies simply stop offering defined-benefit plans.

Jacobson

“Unfortunately, we’re going to see an unprecedented number of freezes and terminations” of such plans, says Jan Jacobson, director of retirement policy for the American Benefits Council, which advocates for employer-sponsored benefit programs. “Now companies’ funding obligations will go up and down with interest rates and market conditions, by hundreds of millions dollars, potentially.”

Many companies, including top-tier names such as Verizon Communications and IBM, have already frozen or terminated plans in recent years as massive failures, market declines and calls for corporate transparency have exposed pension obligations that are vastly underfunded. Companies increasingly are shifting their emphasis toward defined-contribution plans—and the recent pension measure makes it easier for them to do so—where corporate obligations are met with current contributions, not future payouts subject to a host of uncertainties.

Enacted by Congress at the end of July, the Pension Protection Act of 2006 is the most comprehensive change in corporate pension requirements since 1974. The White House has promised to sign the bill later this week.

The law sets new minimum funding requirements for companies to meet, restricts the use of credit balances to offset minimum contribution requirements, eliminates much of the opportunity for “smoothing” gains and losses from quarter to quarter, and increases fees to the Pension Benefit Guaranty Corp., which bails out defaulted pensions. All those moves combine to increase the cost and volatility of providing defined-benefit plans to employees.

The bill increased the funding target companies are required to meet from 90 percent to 100 percent, Jacobson says. It also rolled back the amount of time companies can take to smooth over their metrics for interest rates and asset values. Previously, companies could smooth a bad turn in interest rates over four years, and a downturn in asset values over five years. The current bill reduced the allowed smoothing period to only two years for both interest rates and asset levels.

“The volatility goes with how the measures are calculated,” Jacobson says. “By eliminating most of the smoothing, you’ll have greatly increased funding obligations at times when interest rates and markets are going down, and you’ll have reduced funding obligations when the markets or the interest rates are going up.”

That will make corporate budgeting difficult, Jacobson says, because companies can’t necessarily foresee changes in market conditions far enough in advance to plan for how they’ll meet contribution requirements. “When you have a company trying to plan their future obligations and they have to look at only a year or two years, with no idea how much they have to contribute, they may not consider it worth continuing their plan,” she says. “The difference could be millions of dollars or hundreds of millions of dollars.”

Gamzon

Further complicating the contribution requirements, warns Sheldon Gamzon, a principal in the retirement practice of PricewaterhouseCoopers HR Services, is the bill’s ban on using a credit balance to fund a current obligation if a plan is less than 80 percent funded.

Prior rules allowed companies to make larger-than-minimum contributions in one year, then apply the excess amount to a future year’s contribution, even if a plan’s assets performed poorly and the plan became underfunded. That gave companies some flexibility to contribute more when cash was flowing and to coast when cash was tight.

“You could have a plan that’s significantly underfunded, yet you still didn’t have to put anything into the plan,” Gamzon says. That provision allowed United Airlines to make no contributions at times when its plan was severely underfunded, he adds.

Jacobson says the ban is meant to address cases just like United Airlines, where plans went into bankruptcy and yet companies weren’t making immediate or recent contributions because of the credit balance provision. Now, she says, there’s concern that companies won’t beef up contributions when cash is available because they won’t as easily get credit for it in the future.

“When you have a company trying to plan their future obligations and they have to look at only a year or two years, with no idea how much they have to contribute … The difference could be millions of dollars or hundreds of millions of dollars.”

— Jan Jacobson, American Benefits Council

And still to come, the Financial Accounting Standards Board is wrapping up its plan to require companies to disclose their pension obligations more prominently on the balance sheet. FASB also plans further overhaul of pension accounting rules, which they have promised will make the accounting more transparent to investors.

Once those provisions begin taking effect—which could happen as early as the 2007 filing season—“We could basically see employers saying enough is enough; we don’t need this anymore,” Gamzon says.

The Silver Linings

Not all is gloom for companies, however. The bill, as well as a recent appellate court decision involving IBM, gives companies new legal footing in offering cash-balance defined-benefit plans.

A cash-balance plan, also called a hybrid plan, is still a defined-benefit plan, but its benefit is promised in the form of a stated account balance. Cash-balance plans were popular into the late 1990s, Gamzon says, but then fell into uncertainty with companies because courts and regulators began to view them as age-discriminatory.

“The new pension bill made it clear on a prospective basis that Congress does not see cash-balance plans as discriminatory,” Jacobson explains. “That makes cash-balance plans another option for employers who find traditional plans are not meeting their needs.” Only a few days later, IBM won a federal appeal in a case where a plan participant said the company’s cash-balance plan unfairly discriminated against older workers.

“Cash-balance plans had really almost been put into a coma because of legislation and judicial uncertainty,” Gamzon says. “Now the cash-balance plan has been put back into business. It will be pretty simple for companies to move from a traditional plan to a cash-balance plan.”

The bill also makes it easier for companies to get employees involved in defined-contribution plans such as a 401(k), to increase participation (and therefore retirement savings) for employees. The new law makes it easier to enroll employees automatically and to offer investment advice that will increase their comfort level, Jacobson says.

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