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Pension Terminations Increase as Funding Improves |
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Monday, 24 April 2006 |
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The pension crisis that hit during the 2000-2003 downturn has eased, with large pension plans showing an increase in their funded status above projected annual returns for the third year in a row.
But the crisis provided an opening for employers to terminate their plans, and that trend continues despite improvements in returns on pension investments. Buoyed by a rising stock market, the average investment return on pension assets was 11.3 percent in 2005, well above the expected average return of 8.5 percent, according to a study of 100 large plans by Milliman. The plans earned $115.9 billion, some $30.5 billion more than the expected return. Over the past three years, the average return on assets has been 14.3 percent. The aggregate pension deficit for the 100 large plans decreased by $14.8 billion during 2005, leaving a deficit of $96 billion. Over three years, the deficit has been reduced by $67.5 billion. Although plan funding has improved, employers are still moving to terminate plans, spurred by the momentum gained when the funding crisis was still at full force. Terminations in 2006 are likely to increase even more because of a proposed change in accounting rules. Under the proposed new rules issued by the Financial Accounting Standards Board (FASB) on March 31, corporations will be required to post the funded status of their plans on their balance sheets. The new rule would take effect on December 15, 2006 and would significantly increase reported pension and retiree health care liabilities and reduce shareholders’ equity for many companies. Had the rule been in effect for 2005, the pre-tax charge to shareholder equity would have been increased by $222.2 billion, according to Milliman. For pension plans, the new rule would measure the benefit obligation as the difference between the fair market value of plan assets and the benefit obligation of the plan. Shareholders and analysts would be fully aware of the funding status of the plan and its potential impact on the future profitability of the company. Although the rule improves the transparency that shareholders and employees need, some companies will rush to terminate their plans rather than comply with the accounting changes. Broad pension reform legislation is now under consideration in Congress. In addition, the various federal regulatory agencies are moving to strengthen the U.S. private pension system. These changes, however, will also vastly accelerate the already substantial trend to simply terminate defined benefit pension plans. New federal legislation passed earlier this year increased premium rates paid by companies for pension plans insured by the Pension Benefit Guaranty Corporation (PBGC). Under the new legislation, flat-rate premiums for single-employer pension plans increase from $19 to $30 a year for each plan participant. For multiemployer plans, the yearly premium rises from $2.60 to $8 per participant. The new rates are effective for plan years beginning on or after January 1, 2006 and will be indexed for wage inflation beginning in 2007. Underfunded pension plans pay an additional variable-rate premium of $9 per $l,000 of unfunded vested benefits. The legislation also introduces a new termination premium payable when a company transfers its underfunded pension plan to the PBGC. The new premium is set at $1,250 per participant per year, payable for three years after plan termination. It applies to certain terminations occurring after January 1, 2006. The PBGC insures the pensions of more than 34 million workers and retirees in nearly 29,000 private-sector defined benefit pension plans under its single-employer insurance program and 9.9 million workers and retirees in about 1,600 multiemployer defined benefit pension plans. Since 2000, 583 pension plans have been terminated, with the average assets per terminated plan growing 20 times over the period, according to the CFO Executive Board. This indicates that large employers are now terminating plans along with the smaller employers who have traditionally underfunded their plans. A recent survey of companies with large pension plans found that almost half plan to terminate or significantly cut their plans unless there is funding relief from the federal government or higher long-term interest rates that would help reduce contribution levels. Employers can end a pension in a standard termination after showing the PBGC that the plan has enough money to pay all benefits owed to participants. If the plan is not fully funded, the employer may apply for a distress termination if the employer is in financial difficulty. |
