Tackling the pension funding crisis. (Washington Insights).

A pension funding issue in Washington cries out for immediate Congressional attention. Failure to act could cost American businesses with defined benefit plans hundreds of millions of dollars, maybe even billions, beginning in 2004.

By law, companies are required to use the 30-year Treasury bond rate to make a variety of pension calculations, including funding requirements for future liabilities, amounts for lump-sum distributions and premium payments to the Pension Benefit Guaranty Corp. (PBGC). However, in October 2001, the Treasury Department stopped issuing the 30-year bond -- though the old bonds are still out there -- and the bond rate has been declining, causing required funding levels to become uncoupled from actual obligations.

To determine funding requirements for a pension plan, a company must determine its future liabilities, then discount that amount back to the present year. For a variety of reasons, including the fact that the U.S. government stopped issuing 30-year bonds, the longest Treasury bond rate is significantly lower than high-grade corporate bond rates. Currently, the spread between the longest Treasury bond and corporate bond rates is wider than historical market levels. As a result, many plan sponsors are required to make higher contributions than what is needed to maintain retirement security for plan participants.

Congress has recognized that as 30-year Treasury bond rates fell, companies were contributing more to their pension plans than was necessary. In March 2002, Congress intervened and enacted a temporary fix, allowing companies to fund their plans at 120 percent of the four-year weighted average of the bond rate. This temporary fix, however, will expire at the end of 2003 unless Congress acts again; if it expires, companies will be required to add hundreds of millions of dollars to their plans above budgeted amounts for 2004.

The Solution

Congress must act quickly to statutorily change the rate that companies use in their pension funding computations. Several interested parties have rallied around a set of principles to guide Congress in its decision-making:

1. Replace the current mandated 30-year Treasury rate with a new composite corporate bond rate. Congress should direct the Treasury Department to select four high-quality long-term indices and average them on a daily basis to determine the new funding rate. Treasury would be required to publish this composite rate daily and could replace any one index within the average, should it fall out of the standard deviation. Such a program would allow Congress to have oversight, but does not require it to intervene regularly to tweak the formula.

2. Phase in the new rate for the purposes of lump-sum distributions. The artificially low 30-year rate has distorted payments from pension plans by inflating lump-sum distributions. These artificially inflated lump sums have discouraged many employees from electing to take their benefits as annuities -- contrary to federal retirement policy -- and have imposed substantial and largely unanticipated cash demands on pension plans.

3. Update the current mortality table. At the time the new corporate rate becomes effective, implement an updated mortality table for funding and variable-rate premium payments to the PBGC. Consistent with current law, the Treasury Department will be required periodically (at least every five years) to review the mortality table and to update it as appropriate to reflect the actual experience of pension plans and projected trends. Mortality assumptions for lump-sum purposes will be updated according to current law.

If your company has a defined benefit plan, chances are that your CEO will soon ask you what your pension costs will be if the current fix expires and the formula reverts back to the true 30-year Treasury rate. Your company needs to know now whether you will be able to purchase new plant and equipment, to invest in research and development, and to accomplish other vital business objectives. The prospect of excessive cash contributions next year may lead many FEI members to severely restrict near-term spending plans until an appropriate replacement for the 30-year Treasury is confirmed.

FEI is actively involved in advocating these positions with Congress and the Treasury Department, and we believe that we are making progress toward a solution. However, in order for Congress to know the importance of this issue for companies in their districts, they need to hear from affected companies. Please take a minute to visit FEI's "Contact Congress" page at http://capwiz.com/fei/home/ and submit a letter to your members of Congress -- a sample letter exists for you there. Thank you!

Bob Shepler ([e-mail]) is Director of Government Relations in FEI's Washington, D.C., office.