Pensions: Are They Just a Toy For Congress to Play With?

In 1963, Studebaker, once a large and proud American auto maker closed its doors in the US for the last time. With that door closing, as legend has it, New York Senator Jacob Javitz had the idea that the retirement income promised to employees needed more security. So was born in his mind the law that in 1974 became the Employee Retirement Income Security Act (ERISA). While it did far more than take steps to make pensions more secure, that was purportedly its primary purpose.

ERISA provided a framework for corporate retirement plans. And, in 1974, before paragraph (k) had been added to Section 401 of the Internal Revenue Code, the predominant employer-provided retirement income came from defined benefit (DB) plans. Unions bargained for them, and what the unions got, management wanted. Also, back in 1974, it was not unusual that if there was a company that an employee worked for in their mid-to-late 20s that that employee would eventually retire from that company. If you, as an employer, promised that employee a pension, you could expect 30 or more years of loyalty from that employee.

So, ERISA set up a minimum funding regime regime for DB plans. If you were using what is known as an immediate gain (or loss) actuarial cost method (if you know what that means, you don't need an explanation and if you don't know what it means, you don't want an explanation), then your minimum funding requirement for the year was the sum of these elements:

• The normal cost or the actuarial present value of benefits accruing during the year
• Amortization over 30 (or 40) years of the unfunded liability remaining from inception of the plan or transition to ERISA
• Amortization over 30 years of the actuarial liability emerging due to changes in plan provisions, the thought likely being that you got 30 years of value from the amendment
• Amortization over 30 years of the actuarial liability emerging due to changes in actuarial assumptions
• Amortization over 15 years of the actuarial liability emerging due to actuarial gains and losses (deviations from the expected)
• A few other elements that rarely came up

By the mid-1980s, DB plans were generally pretty well funded, and most of those that were not yet fully funded were getting much closer than they had been. The exceptions, for the most part, were plans sponsored by companies in dire financial straits that often convinced their actuaries to use fairly aggressive actuarial assumptions, or companies that frequently provided large benefit increases that had not yet been funded.

In 1986, we were graced with the Tax Reform Act (TRA86), a massive and sweeping change to the entire Internal Revenue Code -- so massive, in fact, that the Code was renamed from the Internal Revenue Code of 1954 to the Internal Revenue Code of 1986, a moniker it keeps to this day. A not insignificant portion of TRA86 included changes to pension funding rules. Amortization periods were shortened. For the most part, this increased required contributions for underfunded plans, which in turn increased corporate tax deductions.

Those new rules were revamped quickly. Just a year later, embedded in the Omnibus Budget Reconciliation Act of 1987 (OBRA87) was the Pension Protection Act of 1987. OBRA87 was the annual budget bill. And, has become the trend, each powerful legislator had his own pet spending project. To pay for all that pork, either a revenue generator or a decrease in tax expenditures (a fancy name for deductions) was needed. OBRA87 found a useful tool in DB pension plans. How is that? Just change the funding rules to decrease required contributions and tax deductions will go down which in a backhanded sort of way increases revenue for the government. of course, this was thinly veiled in a complex set of new requirements that applied only to underfunded plans.

A star was born!

Congress needs a revenue raiser? Change the funding rules. Cut the maximum benefit limitations. Change required interest rates. 

With this new toy, Congress looked at changes in pension rules at least every other year. It created uncertainty for employers. Yes, they could plan and budget based on current rules, but they lived in fear that the rules would change. That's a tough way to run a business. Many of those plan sponsors froze their pension plans. Many of them wanted to terminate their plans, but interest rates were so low that the cost of terminating those plans was too high. 

Fast forward to 2006. Coming out of the economic malaise and stock market tumble at the beginning of the decade, many plans were underfunded on an accrued benefit basis using market-based discount rates. It was time to protect pensions yet again. Thus was born the Pension Protection Act of 2006 (PPA), the most sweeping change to corporate pensions since ERISA. It provided a regime that essentially ensured that underfunded plans would be fully funded within 7 years. Employees would get their pensions. 

But, those extra contributions from employers are tax deductible. That's an extra burden on the government. And, it was just one year later (falling from its October 11, 2007 peak) that the markets crashed yet again. Employers couldn't afford these new levels of required contributions. But. Congress had an agenda to help those employers and help themselves. 

Welcome pension smoothing in the form of several laws since then. PPA brought us 7-year funding based on "fair market" conditions and assumptions. Pension smoothing undid that and then undid it again and undid it again as Congress invoked its favorite toy at least 3 times in the period following the signing of PPA. Employers had funding relief. Congress had its decrease in tax expenditures. Employees in pension plans had less funded benefits and the rules got so complex that almost nobody wanted to sponsor a pension plan anymore.

And, the places that pension funding relief gets buried are just amusing. I think the 2014 relief is my favorite -- the Highway and Transportation Funding Act of 2014 (HATFA). That's right. Congress decided it was time to improve our roadway system, but new roads don't come for free. So, to help pay for this, Congress invoked its favorite tax toy, pension funding relief.

Shame on them!

Pension Funding Relief On the Way?

While the Supreme Court was front and center making the big news of the day and the House of Representatives was busy finding Attorney General Eric Holder in contempt, the US Senate appears to have come to an agreement on a bill that would provide for more highway funding and for a better deal for students and prior students on student loans.

I know, what does this have to do with pension funding. Well, leave it to your Congress, because when they do stuff like this, I deny any linkage to them. Buried not so deep in this bill is so-called pension funding stabilization. You remember the pension reform law to end all pension reforms, the disastrous Pension Protection Act of 2006 (PPA), don't you? Well, it hasn't ended pension funding reforms yet and it doesn't look like it's close to doing so.

So, what is pension funding stabilization? Well, in a nutshell, PPA was supposed to do all of these things:

• Force companies to use current (or almost current) discount rates to value their liabilities
• Provide incentives for companies to get their plans better funded
• Get all plans essentially fully funded on a mark-to-market basis within 7 years

That was 2006. Things were rosy. The economy was booming. Interest rates were very low, but surely they were going to get at least a little bit higher.

Find the flux capacitor, Doc Brown. Where's the DeLorean? Let's go back to the future.

A few things have happened since 2006, including various types of pension funding reform. But, they haven't been enough. And, now, Congress in its infinite wisdom is working on legislation that, in my humble opinion, is very wrong.

Before I explain why it's wrong, let's look at the key provision of pension funding stabilization. Currently, companies (and their actuaries) in performing their pension funding calculations get to use an average of rates over the last 24 months. While this isn't quite a spot rate, rates have been in the same general range over the last 24 months, so it's far from abhorrent. And, putting in market-based funding was a cornerstone of PPA. 

Nearly six years after PPA's passage, however, we are in for a change. Should the bill become law, companies will get to average their rates over 25 years. That's a lot of years. 25 years ago was 1987. Rates on 30-year Treasuries, were, if memory serves me (because I am writing this remotely and am not in a position to look it up), in excess of 9% (for at least part of the year). What does 9% have to do with prevailing interest rates today? In fact, even if you believe that pension liabilities should be discounted at an expected long-term rate of return on plan assets, where can you get a consistent return of 9% these days?

If Congress wants to give pension funding relief, the way to do it is to still make companies pay for the cost of current year accruals, but let them pay off their unfunded liabilities on a basis slower than seven years. Instead, they are going to get to full funding on a basis that makes no sense.

Why is Congress doing this? Funding highway improvements and student loan writeoffs takes money. Pension contributions generally result in corporate tax deductions. So, the pension funding stabilization gets scored as a revenue raiser because the asinine rules of Congress look at only 10 years. As you and I know, the cost of a pension is the cost of a pension and no silly rules can change that. This means that those tax deductions are merely deferred. So, in reality, the government is once again spending money on stuff it has no way to pay for. 

Stupid bill!

Yes, stupid bill.