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Guest Article

Deloitte logo

(From the March 7, 2005 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Key Committees Hold Hearings on Pension Reform

The pension funding reform debate took center stage in Washington, DC last week. At a March 1, 2005 Senate Finance Committee hearing and a March 2, 2005 House Committee on Education and the Workforce hearing, representatives from the Administration, the business community, organized labor, academia, and participants' rights groups took turns discussing, describing, dissecting, disparaging, and in some cases defending, the Bush Administration's controversial proposals for reforming pension funding rules and preventing further erosion of the Pension Benefit Guaranty Corporation's (PBGC) financial condition.

Administration's Testimony

The Bush Administration was represented at both hearings by Ann Combs, Assistant Secretary of Labor for the Employee Benefits Security Administration, Assistant Secretary of Treasury Mark J. Warshawsky, and Bradley D. Belt, Executive Director of the PBGC. As they have been doing since early January, the Administration's witnesses reiterated the case for "fundamental and comprehensive" pension reform, and discussed and defended the Administration's specific proposals.

Recurring Themes

All but one of the non-Administration witnesses expressed concerns about various aspects of the Administration's proposals, some more emphatically than others. The American Benefits Council (ABC) acknowledged "a number of themes in the Administration's package that we support," but noted "serious concerns about many of the Administration's proposals." The UAW, by comparison, called the Administration's proposals "dangerous and counterproductive."

Despite the differences in tone, these witnesses' prepared statements offered many of the same objections to the Administration's proposed reforms. Here are the highlights.

  • The Administration's yield curve proposal will increase pension liabilities for many plans and introduce complexities that many small and mid-size employers, and even some large employers, are not prepared to handle. It also may force plans to shift investments from equities to bonds, which could have adverse consequences for the stock market, the capital markets, and the economy as a whole.
  • Using a near-spot interest rate, as opposed to a 4-year weighted average interest rate, to value pension liabilities will not produce an accurate measure of long-term pension liabilities, and will make funding requirements more volatile and less predicable. Requiring plans to determine funding obligations based on the fair market value of their assets, as opposed to the actuarial value of those assets, also will increase volatility.
  • Eliminating the current credit balance system will discourage employers from overfunding their plans during good economic times. (Some witnesses acknowledged credit balances should be adjusted for market performance.)
  • Using credit ratings to determine funding or PBGC premium obligations will further exacerbate problems for financially troubled companies.
  • The PBGC's financial problems are due to the terminations of several pension plans with large unfunded liabilities, and not to any systemic problems that require fundamental reform. Furthermore, the Administration's proposals to dramatically increase the flat-rate premium rate and replace the variable-rate premium with a risk-based premium would encourage healthy companies to terminate their defined benefit plans, thus narrowing the PBGC's premium base.

Of course, these witnesses did not object to all of the Administration's ideas. The ABC, the Business Roundtable (BRT), and the UAW all support increasing the limit on deductible contributions to 130 percent of current liability. The ABC and BRT also supported the concept of enhancing existing disclosure requirements, including improving the summary annual report (SAR). (The UAW did not address the Administration's proposals relating to disclosures.)

The lone non-Administration witness that did not criticize any of the Administration's proposals was Randall S. Kroszner, Professor of Economics at the University of Chicago's Graduate School of Business. According to Professor Kroszner, "The situation at the PBGC today closely parallels the situation in the Savings and Loan industry and its insurer, the Federal Savings and Loan Insurance Corporation (FSLIC), in the 1980s." In order to avoid a taxpayer bailout of the PBGC Professor Kroszner argued for immediate, fundamental reform. Although Kroszner did not specifically endorse the Administration's funding and PBGC premium reform proposals, he embraced many of the same principles: (1) increase premiums and make premiums risk sensitive; (2) prevent firms in distress from increasing their (guaranteed) pension obligations; and (3) require underfunded plans to return to adequate funding levels quickly.

Alternative Reform Proposals

Chairman Charles Grassley opened the Finance Committee hearing by praising the Administration for offering "a tough defined benefit reform package that would strengthen pension funding," and admonishing witnesses to back up their complaints with alternative solutions. Most of the non-Administration witnesses at both hearings complied.

The ABC, BRT, and UAW witnesses suggested targeted reforms to the current funding rules would be better than a complete overhaul. All three supported permanently replacing the 30-year Treasury rate with the long-term corporate bond rate that Congress approved last year for 2004 and 2005 plan years, but only the ABC and BRT witnesses argued for permitting employers to use the long-term corporate bond rate for calculating lump sums. The UAW witness also recommended allowing employers to use collar-adjusted mortality tables in valuing plan liabilities.

Testifying on behalf of the Pension Rights Center, Professor Norman Stein of the University of Alabama School of Law offered several interesting ideas. He suggested the discount rate for funding purposes should continue to be tied to government-issued bonds rather than long-term corporate bonds. Professor Stein also argued the funding rules should reward companies with high credit ratings, such as by allowing them to use smoothing methods to reduce funding volatility, instead of merely punishing at-risk companies. He also proposed an exit charge for employers that leave the defined benefit system, among other things.

With respect to the PBGC, the UAW argued the federal government should issue 30-year bonds to cover the steel and airline pension liabilities the PBGC has recently assumed, or will assume in the near future. According to the UAW, this is preferable to any of the Administration's proposals, which would "inevitably hurt workers and retirees and employers that sponsor pension plans." (Professor Stein also suggested "periodic or episodic appropriations to the PBGC from general revenues" might be appropriate.) Whatever the merits of these arguments, even a limited taxpayer bailout of the PBGC is not politically attractive. As Chairman Grassley pointed out, the 80 percent of workers that do not participate in the defined benefit system may object to subsidizing the benefits of the 20 percent who do.

Cash Balance Plans

Four of the six non-Administration witnesses indicated Congress should address the legal status of cash balance and other hybrid plans as part of the pension reform debate. The ABC and BRT witnesses argued for legislation "affirming the legality of hybrid plan designs," and providing "legal certainty for the hybrid plan conversions that have already taken place." Dr. Janemarie Mulvey of the Employment Policy Foundation joined the ABC and BRT witnesses in cautioning against imposing benefit mandates in connection with cash balance conversions.

The UAW witness argued traditional defined benefit plans are better than cash balance plans for workers and retirees, but acknowledged cash balance plans are better than no pension plan. Thus, "the UAW supports legislation to resolve the legal uncertainties surrounding cash balance plans, by making it clear that they are not per se a violation of age discrimination laws."

However, the UAW also argued for mandatory transition relief for "older workers who are near retirement."

What's Next?

These hearings were only the beginning of what is sure to be a lengthy process. Chairman John Boehner of the House Committee on Education and the Workforce indicated he is planning to introduce comprehensive pension reform legislation in the near future, and other proposals are sure to be forthcoming. Details of Chairman Boehner's bill are not yet available, but he did say at the March 2 hearing that his proposal-- unlike the Administration's proposals-- would include reforms for single and multiemployer plans.

Clearly, the Senate Finance and House Education and the Workforce Committee hearings exposed significant differences between the Administration and the labor and business communities over both the nature of the pension funding problem and the appropriate solutions to that problem. Whether Congress can develop and approve legislation that these various stakeholders will support and the President will sign remains to be seen. But the battle has been joined.

Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Bart Massey 202.220.2104, Elizabeth Drigotas 202.879.4985, Diane McGowan 202.220.2077, Taina Edlund 202.879.4956, Martha Priddy Patterson 202.879.5634, Laura Edwards 202.879.4981, Tom Pevarnik 202.879.5314, Mike Haberman 202.879.4963, Tom Veal 312.946.2595, Stephen LaGarde 202.879.5608, Deborah Walker 202.879.4955, J.D. Lutz 202.879.5366

Copyright 2005, Deloitte.

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