This content is from: Portfolio
Corporate Pension Funds Lobbied for a Rule Change. Now It’s Coming Back to Haunt Them.
Rising rates have radically shifted how corporate plans calculate discount rates.
Nearly 15 years ago, corporate pension plans lobbied Congress to pass a wonky benchmark rule that provided funding relief in the wake of the global financial crisis.
Now, as interest rates have risen rapidly, the rule is coming back to haunt their plan sponsors. The consequences could be painful. In a bear market, corporations could be forced to make contributions to pension plans that are already fully funded.
But it wasn’t supposed to be like this.
Congress has long regulated corporate pension plans, setting rules on funded status and plan sponsor contributions, among other things. Sometimes these rules are included in larger pieces of legislation, such as MAP-21, a 2012 transportation law that happened to include crucial pension funding rules.
Passed in the wake of the global financial crisis, amid a low interest rate environment, MAP-21 allowed pension plan sponsors to use an artificially high discount rate to calculate plan liabilities. In effect, this rule allowed struggling corporations to avoid making pension fund contributions, instead using excess capital to shore up their businesses.
“When corporate bond rates started to plummet because of the recession, we were punishing plan sponsors at the exact time that they were having business trouble,” said Michael Kreps, principal at Groom Law Group.
Corporate plan investors such as Jon Glidden at Delta Airlines’ pension fund had pushed for these changes, with the goal of giving their plan sponsors flexibility and stability.
The interest rates used to calculate the discount rate are dependent on the plan type, its beginning year, and myriad other factors. Congress provided a band, or collar, of acceptable interest rates that a corporation could use. That band has narrowed over time.
“Essentially, they weren’t subjected to the unprecedentedly low interest rates that we were experiencing since 2008,” said Dennis Simmons, executive director at CIEBA, an organization that represents private plan investment officers. “It allowed them that flexibility to run their businesses and make their pension contributions. And ultimately, plans have really improved over the past several years.”
According to Simmons, corporate plans knew this would eventually change. “There was always a notion [that] maybe down the road [rates] would drift up,” he said. But what they couldn’t predict was how quickly the Federal Reserve would move to push interest rates higher.
Now, corporate pension funds are in a bind. Despite last year’s market downturn, many corporate pensions are fully funded. While their corporate arms are reporting lower quarterly earnings, these pension plans are doing fine.
But here’s the rub: Actual interest rates are higher than the artificially high rates used in their liability calculations. “Rather than those historic averages keeping interest rates up, the ceiling hits, and they’re keeping interest rates down, meaning the pension contributions are inflated,” Kreps said.
In other words, plan sponsors may actually have to contribute capital to their pensions, even though the plans are fully funded.
“You could imagine the conversation you’d have to have as a CIO or CFO with the management team, saying ‘Hey, team, our pension fund is pretty well funded, but because Congress proposed this arbitrary cap on interest rates, we have to make a contribution to the plan anyway,’” Kreps said.
There is hope that things could change. According to both Kreps and Simmons, Congress is generally amenable to supporting corporate pension plan needs, given the positive optics of backing both a robust employee benefit program such as a pension and a corporation.
But it will, of course, take time. Kreps noted that Congress usually includes rules like this in a larger legislative package. Due to the complexity of pension funds, it will likely take time and energy to get the language of the bill right.
But there’s a relatively simple way Congress could make a change: Simply allow plans to opt out of the current discount rate calculation rule.
“I think having some period to be able to opt out of the corridors but keeping the existing law, I could envision a solution along those lines,” Simmons said. “You can still have protections for participants, but give plan sponsors some relief for plans that are adequately funded and not requiring artificially high contributions.”