Probably the best thing Congress did with pension reform this
summer was go home without passing a bill. As in most issues,
Senators and Representatives tend to make things way too
complicated, with the help of various elbows in their ribs.
In essence, the problem of “underfunded” corporate pensions
isn’t hard to understand, once you claw through all the scare
quotes about $300 billion shortfalls and the “risky” stock market
and the Pension Benefits Guaranty Corporation (PBGC) and
discrimination against older workers and “cash balance” plans and
all the rest.
First, there are two basic kinds of pension plans, the old kind
and the new kind. In the old kind, a company promises to pay an
employee a certain amount per month upon retirement, an amount
based on that employee’s term of service and salary amount. This is
called a “defined benefit” plan. In the new kind, a “defined
contribution” plan, employees contribute their own pre-tax dollars
to a tax-deferred account like a 401(k), with matching amounts
added by the employer, invest that money over time in a list
(typically) of mutual funds, then withdraw money as needed when
they retire.
Forget the new kind. The controversy over “underfunding”
involves the old kind of pensions.
Those kinds of pensions do indeed tend to fall short of the
amount they should have on hand, for two reasons, one on the asset
side, one on the liability side. On the asset side, the stock
market has gone down for about three years, quite a lot, until
mid-March of this year. So pensions’ investments in stocks have
gone down — also quite a lot. Thankfully, three-year bear markets
don’t happen often.
The liability side gets more complicated. How do you calculate
how much money a pension fund ought to have in it? Multiply the
number of retired and retiring workers by the amount you have
promised to pay them, over a 30-year period. That number, “future
value,” has to be “discounted” for its presumed deterioration over
time due to inflation. You need a “discount rate,” a percentage by
which you will multiply the future value amount. That will yield a
“present value,” and that’s the amount you have to have on
hand.
That discount rate squats squarely in the middle of the current
controversy. Pensions used to use the 30-year Treasury bond rate.
The Treasury Department even let companies presume that their
assets would grow at 120 percent of the face interest rate of the
30-year Treasury. Twofold problem: 30-year Treasuries haven’t been
issued since 2001. And the existing supply has had their price bid
up (low supply, high price), reducing their effective interest rate
to an artificially low level.
So companies’ pension liabilities get kicked up. Add in the
stock market losses, and companies find themselves looking at
greatly increased requirements to pay cash into their pension
funds.
The legislative debate mainly involves changing the former
30-year Treasury rate to something more generous. A higher rate
would allow companies to put in less money to meet their pension
funding targets. As Congress debates, a typical lineup squares off:
labor on one side in favor of a stingier rate, corporate ownership
on the other plumping for a higher one. Congress tries to
“compromise.”
And the press weighs in. With the “stock market is evil” riff,
and its underlying basso contrapunto, “making money is evil.” With
“Enron” (never mind that Enron had a 401(k) plan, not a traditional
pension). With “fears of a taxpayer bailout.”
To be fair, the PBGC has had to take over pension plans for
companies like TWA, Polaroid, and steelmaker LTV. And “old
industry” companies are failing, and the PBGC has cause for
concern. Also to be fair, industry’s latest fix — a “cash balance”
plan conversion, too complicated to describe fully here — has, in
its earliest iterations, been found by a recent court decision to
discriminate against older workers. IBM and Xerox took this
decision on the chops. Companies weighing in later profited from
IBM and Xerox’s experience to craft cash balance conversions that
can pass the discrimination test.
The Bush administration’s pension reform proposal, issued in a
government release on July 8, closely matches the one passed by the
Senate when legislative sessions resumed after Labor Day. The
Senate bill would raise the discount rate for pension planners for
three years (against two years in the Bush plan), after which a
“yield curve” plan would go into effect, matching liabilities
(workers’ needs at various ages) to appropriate assets.
Historically, all this must be set into a context. “New economy”
companies have almost universally elected to use 401(k) type plans,
and new economy employees almost universally want that kind of
plan. What does a defined benefit plan do for today’s typical
knowledge worker, who changes jobs six or seven times in his
working life? 401(k)s are portable; so are the new cash balance
conversion plans.
In other words, regular old pension plans are disappearing. For
now, however, pension reform for these old economy plans has to
address two needs: Keeping the companies solvent, and keeping
workers’ benefits in place, and in the private sector.
This is no time to kick capitalism in the teeth, tempting as
that may be for some legislators.
