The passage last year of the Moving Ahead for Progress in the 21st Century Act was in part aimed at helping corporate pension plans meet their funding requirements.
To a point, it has, but the legislation may not have done much to slow the demise of traditional pension plans.
MAP-21 was actually a highway bill that contained a little-publicized provision that allows companies to set their pension plan contributions using a rate based on high-quality bond yields averaged over 25 years. Before MAP-21, the rule was two years using current rates.
Employers have to put in more money into their pension plans when rates are low and, conversely, put in less when rates are higher. The 25-year average is expected to be at least 2-3 percentage points higher than rates today.
The change was a godsend to companies experiencing cash flow issues, allowing them to redirect cash otherwise destined for higher pension fund contributions to fund other, more immediate needs. As a result, many companies responded to the MAP-21 rule by lowering their pension contributions for 2012, some by double-digit percentages.
Others, however, kept their plan funding at pre-MAP-21 levels or perhaps even increased it. And they may be the wisest of the lot, because MAP-21 may have provided the wrong route — at least for some.
In its latest corporate pensions outlook report, Fitch Ratings said that, although it “believes near-term prospects signal potential funding improvements, companies contributing the minimum under recent funding relief (MAP-21) may face a day of reckoning in the coming years due to the potential for a steep acceleration of funding requirements.”
Fitch reviewed 224 nonfinancial U.S.-based companies with DB plans having U.S. projected benefit obligations of $100 million or more. Of those, 148 were less than 80 percent funded.
The ratings agency said that “for a company on the edge of a rating category, weak earnings and the need to make ongoing pension contributions could lead to a negative rating action.”
According to the UBS Global Asset Management US Pension Fund Fitness Tracker, the funded status of corporate pension plans was up by a considerable margin in the second quarter of 2013, helped along by strong market performance and an increase in interest rates. But neither factor was enough, and many plans remain sorely underfunded.
Fitch has already said that problems could arise down the road that would make it wiser for companies to keep the contributions coming.
In other words, if market returns aren’t strong enough, companies that don’t make adequate contributions to their plans could be in for some uneasy times. And, of course, there’s been no shortage of speculation about when the current bear market might end.
The other big factor in all this is, again, the discount rate, which is still low — thanks to continued low interest rates. Low interest rates mean a low discount rate, which increases funding level requirements. Rates are expected to rise as the economy continues to improve, but there’s no guarantee of what might happen.
So, what can be done to help the situation?
According to Charlie Service, global co-head of retirement and advisory solutions at UBS, the best answer is “derisking” – though it’s best to view how well this strategy might work over the longer term.
Companies that derisk do so by changing the mix of their plan investments in favor of LDI, or liability-driven investments.