Firms May Raise Payments to Ease Transition
The bill, which was approved by large margins in the House and Senate and has been sent to President Bush, requires that companies fund 100 percent of their pension promises over seven years. But the healthier a plan is by September 2007, the more time it will receive to make the transition—perhaps a total of 10 or more years.
"There will be a real incentive to fund these plans over the next 12 months," says Kevin Wagner, retirement practice director in the Atlanta office of Watson Wyatt.
Generous transition means the Pension Benefit Guaranty Corp. probably won’t eliminate its $23 billion deficit anytime soon, according to Bradley Belt, former PBGC executive director.
Belt, who helped formulate Bush’s stringent pension proposal, gave the congressional reform a mixed review.
"It’s a partial long-term solution," he says. "In certain key areas, it’s an improvement over current law. It’s clearly not a panacea. It won’t ensure that taxpayers won’t bail out (the PBGC) over the long haul."
After years of effort, Congress finally reached agreement on the complex bill in late July. Legislative activity has been fostered by several recent large pension defaults and estimated total underfunding of more than $300 billion in defined-benefit plans that cover 44 million employees.
The pension bill prohibits the use of credit balances in plans that are less than 80 percent funded. It subtracts the balances to determine the funding level. It forces companies to pay higher "at risk" premiums if plans are below 80 percent and slip to less than 70 percent, assuming that workers eligible to retire in the next 10 years do so as early as possible. It reduces interest-rate smoothing to 24 months. And it proscribes increasing benefits if a plan is below 80 percent funding.
In a concession to airlines, carriers will receive between 10 and 17 years to reach 100 percent funding, depending on whether they have frozen their pension plans. Despite the break, Delta terminated its pilot pension plan on August 4, a move that it foreshadowed even as it appealed to Congress for extra time to save pensions covering other employees.
"You still have a hodgepodge of rules," Belt says. "It’s a reflection of the sausage-making process."
Analysts agree that the new sausage will be spicy—in the form of higher payments, either to meet the 100 percent funding mandate or to avoid costly "at risk" status.
"Plan sponsors are much more focused on staying above these trigger points," says Jon Waite, chief actuary of SEI Global Institutional Group. The new rules "are going to drive a lot more money into pension plans."
Waite estimates that a $100 million plan funded at 90 percent, the requirement of current law, would pay an extra $2 million annually, or a 30 percent to 40 percent increase, to meet new funding targets.
Despite the rise in costs, companies are relieved to have certainty after years of limbo.
"This bill in and of itself doesn’t make plans onerous," Wagner says. "This should stop some of the momentum (to dump defined-benefit plans) because we know what the rules are."