16 June 2019

The World of ‘Pension Smoothing’

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President Barack Obama on Friday signed a $10.8 billion transportation bill that extends a “pension-smoothing” provision for another 10 months. In short: companies can delay making mandatory pension contributions, but because those payments are tax-deductible some businesses will pay slightly higher tax bills, which will help pay for the legislation.

Companies with 100 of the country’s largest pensions were expected to contribute $44 billion to their plans this year, but that could be slashed by 30% next year. International Paper Co, for example, had planned to set aside $1 billion by 2016 to fund its $12.5 billion U.S. defined benefit plan. The paper company says it now expects to funnel that money into other projects, including share buybacks or investments in new plants.

But the accounting tactic is controversial. The government’s moves could undermine its own efforts to shore up the pension system. Some worry about the strain it could put on the government agency tasked with protecting the retirement of 44 million workers.

Companies have struggled to keep up with mounting pension bills since 2008. The present-day value of those promises increases when interest rates decline. Currently, the largest pensions have a $252 billion funding deficit, which has increased by $66 billion since the beginning of the year.

The accounting maneuver was introduced in Congress’s last highway bill in 2012, and was backed by large business groups, such as the Business Roundtable. The new bill, which expires in May, will extend the method.

The bill essentially allows companies to base their pension liability calculations on the average interest rate over the past 25 years, instead of the past two. The 25-year average is larger, because interest rates were much higher before the financial crisis.

The accounting technique doesn’t actually reduce companies’ obligations to retirees. Instead, it artificially lowers the present-day value of future liabilities by boosting the interest rate companies use to make that calculation.

The risk is that pension smoothing will ultimately increase corporate pension deficits by encouraging executives to delay payments, says the Congressional Budget Office. For instance, more companies could default on their obligations to retirees.

The financial health of the government’s PBGC is improving. The agency has mapped out different scenarios of economic growth and estimated its fund to cover defaults will have an average deficit of $7.6 billion in 2023, down from $27.4 billion late last year.

Pension smoothing measures will only add $2.3 billion to its estimated deficit. The AFL-CIO, the nation’s biggest labor union federation, says it supports pension smoothing because it reduces volatility to balance sheets, which makes the prospect of offering pensions less daunting.

Under a 2006 law, companies need to make their plans whole over time. Pension smoothing provisions both artificially and temporarily make funding levels look healthier, so companies can lower their contributions.

Some companies will continue to finance their pension plans. Boeing Co. says it won’t change its strategy and still expects to make a discretionary $750 million payment to its $68.6 billion in pension obligations.

Click here to access the full article on The Wall Street Journal. 

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