The House-passed budget bill threatens the pensions of 25 million in single-employer pension plans (sponsored by one employer) by undervaluing pension promises and giving companies excessive periods to address underfunding. This is particularly galling in a bill providing massive taxpayer bailouts to union multiemployer plans, which are underfunded due to these very flaws.
If enacted, the provisions will eventually cause retirees to lose benefits, destabilize the Pension Benefit Guaranty Corporation that helps guarantee these pensions, and perhaps bring future taxpayer bailouts.
The cost of a pension is the market price of a bond with the same duration. For example, the cost of a $100 promise due 10 years from now is the cost of purchasing a bond maturing in 10 years with a value of $100. A pension plan can instead purchase a risky asset such as stock for half the price of the bond. The asset may appreciate to $100 or become worthless in 10 years, but this does not affect the cost of the pension.
As Jeremy Gold testified to the Ways and Means Committee: “The assertion that investment doesn’t impact costs is often disputed but can be illustrated by a simple analogy. If an automobile costs $30,000, it costs $30,000. If I invest my assets successfully, I may be better able to afford the automobile. But the automobile still costs $30,000.”
To safeguard workers and retirees, the Pension Protection Act of 2006 requires single-employer plans to measure pension liabilities accurately using a high-quality corporate bond yield curve. To minimize volatility in required contributions, plans may use a two-year average of rates instead of the rates on the measurement date. Employers must fund shortfalls within seven years. As a result, these plans are 79% funded, compared to 42% for multiemployer plans.
The Great Recession and slow recovery prompted Congress to postpone required pension contributions, including by using 25 years of higher historical interest rates to measure liabilities. But this questionable policy was effectively temporary and also accompanied by much higher premiums by the Pension Benefit Guaranty Corporation, particularly a variable rate premium on Pension Protection Act-based plan underfunding, providing a strong incentive for employers to fund pensions on a market basis. In response to COVID-19 shutdowns, the CARES Act postponed 2020 contributions until 2021, and some additional relief is arguably appropriate.
Interest rates have been decreasing for more than 30 years, which means pensions have become more costly. To avoid the higher contributions needed to fund the plans, some have long advocated disregarding the market value of liabilities and very long periods to address underfunding with the argument that temporary pension underfunding is unimportant over the long term. But “temporary” pension underfunding has very real negative consequences to workers and retirees if their employer goes bankrupt.
The budget bill adopts this flawed multiemployerlike approach, completely and permanently divorcing the measurement of pension promises from reality by instituting a 5% floor on discount rates, which is ten times the most recent rate for shorter term bonds, 0.50%. Compounding the risk to participants is a “fresh start” wiping out existing scheduled contributions and permanently providing 15 years to fund shortfalls, just like multiemployer plans.
Participants in troubled plans will be hurt the most. At an annual rate of 4.6%, the variable rate premium incentivizes most companies to fund their plans fully on a Pension Protection Act basis regardless of required contributions. However, the variable rate premium has a per participant cap, so plans with underfunding exceeding $12,650 per participant face no increased premiums by the Pension Benefit Guaranty Corporation on becoming even more underfunded.
This will inevitably result in deeper underfunding of plans taken over by the Pension Benefit Guaranty Corporation, leading to cuts for retirees and undermining the corporation’s finances. Although the corporation’s single-employer program has a fiscal 2020 surplus of $15.5 billion, its reasonably possible exposure increased to $176 billion even before COVID-19. This will mean future increased premiums from employers responsibly funding their plans or more taxpayer bailouts.
When workers are promised a pension, they should be able to count on receiving that pension, even if their employer goes bankrupt and without taxpayer bailouts. Further temporary funding relief in response to the COVID-19 shutdowns is debatable, but creating a permanent artificial floor for pension discount rates denies reality, as if Congress could declare the value of pi to be 2.14.
The budget bill’s pension subtitle has nothing to do with COVID-19, and it spits in the face of taxpayers, workers, retirees, and responsible employers alike by providing a massive taxpayer bailout to multiemployer plans while simultaneously undermining the finances of single-employer plans with rules that are among the prime causes of the multiemployer dysfunction.
Aharon Friedman has worked on tax policy issues for more than a decade. He served as senior adviser to the assistant treasury secretary for tax policy and as senior tax counsel to the House Ways and Means Committee.
