Are Company Cutbacks Helping or Hurting Pension Plans?
For anyone relying on company-funded pension plan payments, it sounds like more bad news: Companies have been reporting huge cutbacks on pension payments.
Just this week three companies, Sears Holdings, Alcoa, and AK Steel Holding slashed payments by a total of nearly $1 billion. More companies are expected to follow suit in the earnings period ahead.
Why are they raiding employee pension accounts when according to a recent survey by Credit Suisse nearly all U.S. defined benefit pension funds are already underfunded in an estimated 97 percent of companies? Defined benefit plans owe workers $2 trillion in payouts, and they have only $1.5 trillion in assets set aside to cover them, according to estimates by consulting firm Mercer. Like the federal budget deficit, this private sector deficit just keeps widening.
So why are companies rushing to reduce payments?
The answer is simple: Because they can.
The charges companies are taking are an immediate hit to earnings, because they lose the tax deduction for the year on pension contributions.
Congress last month passed new rules that lowered the amount of pension fund contributions companies are required to contribute, effectively cutting their required contributions in half by allowing them twice the credit for contributions over the next two years. (The change is not permanent.)
It was a compromise that had something for everyone in Washington: The pension magic raises tax receipts without raising tax rates. Companies end up with more free cash for present day liquidity needs, even though they will pay significantly more taxes and slight increases in pension insurance. Plan participants will get promised payments, the same as ever.
“If funding contributions are reduced, there is no immediate impact on the participants in most cases,” said Jack VanDerhei of Employee Benefit Research Institute. In some rare cases, the funding decline could trigger a freeze in the pension plan’s overall coverage, he said.
But labor officials and businesses, the two key stakeholders, were in accord that the moves would help the pension system meet its costs and continue paying participants.
So what is wrong with a plan that seems to benefit everyone?
“You have to worry a bit when those two (big labor and management) agree,” joked David Zion, pension analyst for Credit Suisse. “This does nothing to the underlying pension funding, it just changes when they are paid. In the long term, it could add to their costs and risks.”
It means Congress has once again abandoned plans to make the pension system more secure and to fully protect taxpayers from bailing out pensions covered by government-backed insurance.
“It’s corporate America’s version of ‘kick the can.’ Just like Europe,” said Zion.
Bruce Cadenhead, a partner and senior actuary at Mercer, said company chief financial officers pushed for the plan because they have been alarmed by the volatility in the pension formula in recent years. Companies have been gradually reducing reliance on defined benefit plans and shifting to defined contribution plans such as 401(k)s. Pension consultants expect CFOs to use this breathing space in defined-benefit plans to shift still more retirement benefits into 401(k) plans.
“Company CFOs like them (defined contribution) because it’s easier to turn them off and on as a temporary measure to deal with changes,” Cadenhead said.
In response to the liquidity crisis during the 2008 crash, many companies stopped paying matching funds for 401(k) plans entirely. It was not as easy for them to cut payments to fund traditional pensions. The only choice was to freeze future commitments to fund traditional pensions, which many did. As the crisis eased, the matching funds returned, but not traditional plans.
Public sector employees are losing defined benefit plans at an even faster rate as municipalities hit budget crunches. Public sector pensions do not have the same ERISA protections as private sector employees, and cities and states have been able to push for concessions from labor in new agreements.
“The uncertainty is being shifted from employers to individuals,” Cadenhead said. “That is the long-term trend. It puts a heavy burden on individuals. Managing those assets is very difficult.”
Companies this year will be liberated from the immediate burden of rising retirement costs, and will have as much as $100 billion in unexpected corporate cash flow. But in the “upside down world of pensions,” the move will reduce earnings, said Zion, due to loss of tax breaks — a key reason for recent charges.
For those relying on pension payouts for retirement, the recent cuts should not be alarming. Their pensions are on the same slippery slope they were on at the start of the year.
—By CNBC.com Contributor Richard Satran