The White House Plan

Depending on your perspective, President Bush’s proposal to reform pension insurance is either a life preserver for the Pension Benefit Guaranty Corp., or an iron yoke that will pull the private pension system straight to the bottom. The White House plan, unveiled in January by U.S. Labor Secretary Elaine Chao (also chair of the PBGC board of directors) has provoked strong responses from almost everyone with a stake in the private pension system. PBGC Executive Director Bradley D. Belt has endorsed the proposal. Business and employee groups, including the American Benefits Council and the United Auto Workers union, have come out against its key provisions.

The plan promises to put the PBGC on a firmer financial footing and does much to counter moral hazard, taking away the opportunity and incentive for employers to offer their workers generous pension benefits and then fail to follow through. It also inflicts pain on companies, especially those already at high risk for defaulting on their plans. “The good thing about the plan is that they’ve actually proposed something that I believe if passed would take care of the PBGC’s financial problems,” said Douglas J. Elliott, president of the Center on Federal Financial Institutions. “The bad part of it is that they’re doing it in a way that’s going to put very heavy pressure on weak companies that have substantial underfunding.”

If enacted, the plan would

• Increase premiums.
  The fixed, per-participant premium paid by all plan sponsors would rise from $19 to $30, a figure that reflects the growth in worker wages since 1991. Future increases would be indexed to wage growth. In addition, companies with underfunded plans would be required to pay higher variable or “risk-based” premiums, with less-than-creditworthy firms paying the highest rates. The White House’s Office of Management and Budget estimates that premium hikes would net the PBGC an additional $15.4 billion in income in the years 2006 through 2010.

• Tie funding rules to default risk.
  A company with junk credit would have to base its funding requirements on its termination liability—the amount due if all workers retired early and demanded their pension benefit in the form of an immediate lump-sum payment. In most cases, that would require the firm to make substantial extra contributions to its pension plan, making up the funding shortfall within seven years. Risk-based funding rules would also prohibit employers with severely underfunded plans, bad credit or bankruptcy papers from increasing pension benefits until they have the cash to pay for them. “We will put a stop to financially strapped companies promising generous new retirement benefits they cannot afford,” Chao said in a speech to the National Press Club.

  In contrast, employers with healthy, well-funded plans catch a tax break; the proposal eases restrictions on overfunding (making additional tax-deductible contributions to cushion plans against hard times).

• Permanently raise the interest rate employers use to compute their funding obligations.
  As they’re permitted to do now under temporary legislation, companies would use a “discount rate” based on long-term corporate bond yields to figure the present value of future pension liabilities. Abandoning the lower 30-year Treasury bond rate previously used to calculate liabilities effectively reduces the contributions employers must make to their plans. But the rate switch comes with a twist: The discount rate would be calculated on a yield curve, an analytical tool that tracks the increasing yields of fixed-income securities over time.

  The administration claims that adopting a yield curve would more accurately gauge funding requirements by matching the discount rate to a company’s specific workforce demographics. A company with a high proportion of older workers approaching retirement would use a shorter-term rate—and therefore be required to make bigger pension contributions today—than a firm with more young workers on its payroll. Business groups disagree, arguing that such an approach would increase funding volatility and be too complex for small companies to implement.

• Expose pension plans to more public scrutiny.
  Presumably, better-informed workers, investors and regulators are in a better position to cajole employers into making up funding shortfalls. The Bush plan would make certain financial data (such as a plan’s net asset value and employer contributions) available to the public as well as the PBGC. And companies would be required to report that information without delay.

The Bush proposal would also freeze the PBGC guarantee limit when a company enters bankruptcy and eliminate coverage of shutdown benefits (that is, additional pension benefits negotiated by unions to protect older workers when manufacturing plants close). One idea that the plan doesn’t broach is erasing the PBGC’s deficit with general revenue; the premium hikes, tightened funding rules and other reforms are intended to balance the agency’s books going forward, thereby shrinking the deficit over time.

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