Author: Paula L. Green
Surging stock markets and some long-awaited rule changes are making the United States’ underfunded pension funds look healthier. But the improvement may be short-lived.

a_1 Corporate financial executives are still feeling the heat when it comes to anteing up extra money to keep their defined benefit pension plans properly funded.
Corporate pension plans are still mired in a financial crisis—costing them billions of dollars—even though stock markets have surged by double digits, interest rates on some bonds have inched upward, and a piece of favorable pension legislation is now winding its way through the US Congress. And at least one study, by Credit Suisse First Boston, says the funding levels of the defined benefit plans of many companies in the S&P; 500 are in worse shape as 2003 draws to a close.
The culprit most frequently cited is consistently low interest rates, which corporations use as part of the calculation when tallying their pension plan obligations. “The situation may be a surprise to plan sponsors as assets have performed reasonably well … there are solid returns,” says Yves McGale, a principal at Mercer Human Resource Consulting in Norwalk, Connecticut. “But the value of the liabilities has grown more than expected. That’s because of the decrease in the discount rate.”
Many corporations across Europe and in Japan with similar types of pension plans are also facing crises, as consistently low interest rates and the lower equity returns that preceded this year’s market upticks have left plan sponsors with funding gaps. In Europe the situation varies from country to country, with the scenario in the United Kingdom most closely mirroring conditions in the United States. Significant equity investments on the part of plan sponsors as well as more stringent funding regulations have resulted in underfunded plans for an increasing number of UK corporations, analysts say.
On the other hand, Dutch pension plans haven’t suffered as much because more funds were invested in bonds. But many corporations throughout Europe have followed the US lead and moved away from defined benefit plans under the pressure of tighter funding requirements and other regulatory restraints.
The financial health of corporate pension plans in Japan is even more dire than in the United States, as generous benefits, an aging population and interest rates that began falling 10 years ago have crimped their balances. Japan doesn’t have a federal agency similar to the Pension Benefit Guaranty Corp. in the US to monitor the plans’ financial soundness or pay retirees’ benefits if a company declares bankruptcy. And in many Japanese corporations, less than half of a firm’s pension liabilities are actually funded—meaning backed by funds in a company account.
“That means when you retire, there has to be a solvent company,” says Mark O’Reilly, a principal in the Chicago office of Deloitte. “The projection of pension health in Japan is even poorer than in the United States.”
Yet despite the low-interest-rate climate in the United States, many analysts are more optimistic about the financial health of Corporate America’s pension plans than they were nearly a year ago when some of the lowest interest rates in four decades and plummeting equity returns had created a bleak outlook.
“Things have eased a bit. There are higher stock market prices on the equity side, and yields are up a bit on bonds,” says O’Reilly, noting that the Standard & Poor’s 500 index has increased more than 20% since its low in March of this year. Adds Charles J. Clark, senior vice president of Aon Consulting in Somerset, New Jersey, “There’s a bigger sigh of relief because you see a lot of improvement in the asset value.”
One positive development that will help take the bite out of low interest rates is US legislation that could save companies doing business there billions of dollars in 2004 when meeting the minimum funding obligations of their defined benefit plans. In a study released in October, Credit Suisse First Boston estimates that many of the 369 companies (or 74%) in the S&P; 500 with defined benefit plans will have to contribute a combined $21 billion to their pension plans in 2004 if some version of the legislation now before Congress is passed. But if the funding calculations revert to the old rules, these corporations will have to ante up $18 billion more between them—a total of $39 billion.
And that’s money analysts say corporations could be using for new capital investments, hiring employees or research and development. “There’s a whole process of prudent financial planning that gets subterfuged,” says Clark. “[Underfunding] doesn’t allow the corporation to focus on the setting of goals.”
The various pieces of legislation now before Congress would help companies by letting them use an interest rate based on a composite of long-term conservative corporate bonds that more accurately reflects market conditions. Currently, corporations must use a lower interest rate that is based on the defunct 30-year treasury bond, which, they say, forces them to kick in more money than is truly necessary to meet the minimum funding requirements set by ERISA.
But even this temporary relief, wrapped in legislation that began two years ago, expires at the end of this month. If no new legislation is passed, corporations must revert to using the 30-year treasury bond in their calculations, which will force them to kick in even more money than now. Analysts are optimistic that a reconciled version of legislation passed by the US House of Representatives in early October and a bill reported out of the Senate Committee on Health, Education, Labor and Pensions in late October will receive approval by year’s end.
Corporate executives and the analysts who look at the health of these plans are happy. “Companies are looking for the ability to fund plans using interest rates that make sense,” says Clark, who is also an actuary. “The use of the 30-year treasury benchmark is broken.”
Many analysts are hoping that Congress incorporates the three-year provision of the Senate bill, rather than the two years laid out in the House legislation. Besides providing stability for another three years, the legislation would create a commission to take a comprehensive look at how the regulations surrounding defined benefit pension plans need to be reformed.
“That’s positive because we don’t want to reform the system piecemeal. There’s too much potential for unintended consequences,” says Judy Schub, managing director of pension and investment policy at the Association for Financial Professionals in Bethesda, Maryland. The Senate bill calls for a commission—composed of members of the US Congress, administration, corporations, labor and plan participants—to prepare a report by the end of 2005.
But McGale of Mercer says that while the legislation is a positive step and may offer temporary relief, plan sponsors still have tremendous pressure to make adequate contributions over time to meet their pension obligations. “To the extent that capital can be invested back in the business and there is more flexibility, that is a good thing,” says McGale. “But the old rules forced companies to overfund in the short-term. If you fund less now, you have to fund more later.”
Adds Kevin Wagner, retirement practice director in the Southfield, Michigan, office of Watson Wyatt: “All-in-all, things are healthier than they were at the beginning of the year. But the underfunded status should cause a lot of concern. It’s a drain from capital endeavors and has a material impact on business activity. There’s a lot of angst. There’s every reason for it to be a big deal.”

By Paula L. Green