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hay rick

hay rick's Journal
hay rick's Journal
July 19, 2012

The collapsing middle class- now they are going after pensions.

The story as reported.

On July 6th, President Obama signed the "Moving Ahead for Progress in the 21st Century Act", also known as MAP-21. Headlines chronicling the event focused on the extension of lower interest rates on student loans. Second billing on this bipartisan legislation went to the reauthorization of federal funding for transportation programs, which was touted by the administration for creating jobs. The law also dealt with various unrelated matters, including taxation of roll-your-own cigarette machines and changes in pension regulations...
Typical coverage of the bill here: http://www.cnn.com/2012/06/29/politics/congress-highway-bill/index.html

The very last paragraph of the article includes a single sentence on pension funding: "During negotiations this week, legislators decided the revenue to pay the $6 billion cost should come from changes to the way companies fund pension programs..." The media focus on student loan rates meant that the change in pension funding went mostly unnoticed and unremarked.

Pension fund "stabilization."

An AP article in the Money section of USA Today gives the new pension legislation more coverage, including this summary of its content and effects (emphasis added): http://www.usatoday.com/money/industries/story/2012-07-09/New-law-gives-companies-pensions-break/56114600/1

A new law will let companies contribute billions of dollars less to their workers' pension funds, raising concerns about weakening the plans that millions of Americans count on for retirement.
The bill Obama signed into law on July 6 renews transportation programs and extends low interest rates on student loans. It was partly paid for by changing pension laws. It would raise around $10 billion over the next decade by gradually boosting the premiums companies pay the government to insure their pension plans, and another $9 billion by changing how businesses calculate what they must contribute to their pension funds.

That computation change will let companies estimate their pension fund earnings by assuming the interest rate will be near the average of the past 25 years, rather than the past two years when interest rates have been extremely low. Since they will now be able to assume that their pension investments are earning higher profits, they will be required to contribute less money from corporate coffers to make up the difference.

The government makes money because companies will make fewer pension contributions, which are tax deductible.

The cover story.

The Pension Fund Stabilization provision in the new law is a compromise primarily designed to serve two purposes- to provide more revenue for existing government programs and to reduce annual pension contributions for companies. From the New York Times: http://www.nytimes.com/2012/06/29/business/tweak-in-a-pension-rule-could-finance-roads-and-student-loans.html

Congress has been struggling for years to find a new source of money for roads and other infrastructure, because the main source, an 18.4-cents-a-gallon tax on gasoline, no longer covers the cost. The gas tax has not been changed since 1993, and as oil prices have spiked in recent years Americans have been switching to more fuel-efficient cars and driving less.

Pressure has also mounted this year to find a way to keep the interest rate on Stafford loans from doubling on Sunday, when a five-year rate relief program is set to expire. The current rate, 3.4 percent, will rise to 6.8 percent without an extension, affecting more than seven million students who are expected to take out such loans for the next academic year.

Lawmakers tussled over other sources of money, with Republicans and Democrats shooting down each other’s proposals, until pensions came into focus, both as a possible revenue source and a much-needed piece of bipartisan common ground. Lawmakers of both parties are inclined to find ways to help companies operate their pension plans...

Low interest rates may help the economy overall, but they are a hardship for the companies that offer pensions to their workers. When interest rates are low, the funding rules call for companies to put more money into their pension plans, on the assumption that the money will compound more slowly. And this year, because the economy is still weak, companies with pension plans were back on Capitol Hill once again, asking for additional help. But this time they proposed a new way of calculating pension obligations, by adjusting the interest rates they use to calculate contributions.

Estimates of the near-term savings on corporate contributions vary. According to Jacques Goulet, US leader of Mercer's Retirement, Risk & Finance, "...relief could be in the range of $40 to $50 billion for S&P 1500 plan sponsors for 2012 and could total well over $100 billion through 2014." The Society of Actuaries, quoted in the AP article in USA Today, estimates that the reduction in contributions will be $35 billion this year and will peak at $73 billion next year.

Just three days after the bill was signed, the first shoe dropped when AK Steel announced it was cutting its planned pension contribution for 2013 from $300,000,000 to $200,000,000.

What it means.

While the legislation was tailored to suit the needs of Congress and corporations, it did so by shortchanging the needs of pension plan participants and, quite possibly, taxpayers. Congress and the companies got a quick cash infusion while the public got more risk and less solvent pension plans. The loosening of funding standards comes at a particularly bad time as far as the plans are concerned. Milliman, Inc. reports on the condition of the largest pension plans: http://www.businessinsurance.com/article/20120709/NEWS03/120709911

Funding levels of pension plans sponsored by large publicly-held U.S. employers plunged in June as lower interest rates fueled a rise in plan liabilities, Milliman Inc. said in an analysis released Monday.

Defined benefit plans offered by the 100 U.S. employers with the largest pension programs were an average of 75.6% funded as of June 30, down from 77.9% at the end of May 31.

In all, the funding deficit jumped $77 billion last month. At the end of June, the value of aggregate plan assets was $1.283 trillion, while the value of plan liabilities was $1.698 trillion. That resulted in a $415 billion deficit, up from $358 billion at end of May.

"With the help of the lowest discount rate in the 12-year history of our study, corporate pensions last month saw their funding deficit increase, to a near-record $415 billion,'"John Ehrhardt, a Milliman consulting actuary in New York and co-author of the analysis, said in a statement.

This is a continuation of the recent trend as shown in the chart below (also from Milliman):

It is difficult to believe that relaxing contribution requirements at this time will not exacerbate the trend toward pension fund insolvency. Perversely, the cash injection into corporate coffers comes at a time when companies are already sitting on record amounts of cash. From the Wall Street Journal: http://online.wsj.com/article/SB10001424053111903927204576574720017009568.html

Corporations have a higher share of cash on their balance sheets than at any time in nearly half a century, as businesses build up buffers rather than invest in new plants or hiring.

Nonfinancial companies held more than $2 trillion in cash and other liquid assets at the end of June, the Federal Reserve reported Friday, up more than $88 billion from the end of March. Cash accounted for 7.1% of all company assets, everything from buildings to bonds, the highest level since 1963.

In short, this is money that many companies don't need. But in a business culture in which the only acceptable motive is profit, leaving money on the table is viewed as weak, foolish, or irresponsible, and greed trumps decency.

If the economy continues to wallow in a long-term recession, the Fed is likely to extend its zero interest rate policy (ZIRP). As it is, the Fed has already announced that it will extend ZIRP through late 2014. Facing continuing low returns on their pension fund assets, companies will surely want to extend their benefit contribution holiday. Given the bipartisan support for MAP-21, it is difficult to imagine that companies would not get an extension if they lobbied for it. Recent history reinforces this point. The Pension Protection Act of 2006 tightened pension funding requirements. The provisions of the PPA were supposed to be phased in gradually, including a stipulation that any "funding shortfall" would be amortized over a seven year period starting in 2008. Additionally, the act provided for accelerated funding requirements for "at risk" plans- where "at risk" is defined as less than 80% funded. Sadly, the good intentions of these reforms disintegrated with the passage of MAP-21.

Artificially inflating the "expected" return on existing pension fund assets serves no useful purpose except to reduce current employer contributions. The contribution shortfall is then replaced by projecting increases in asset appreciation and interest income which are counted on to make up the difference. Sound financial practice is abandoned and replaced with an appeal to wishful thinking or the power of prayer. This is exactly the sort of thing that someone with questionable motives might do with other people's money. Nobody in their right mind would do it with their own money, especially if they were relying on those funds for retirement.

For those interested in the subject, more reading:

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