Why It Makes No Sense

One of the ideas bandied about within the Joint Select Committee on Solvency of Multiemployer Pension Plans was the idea that discount rates (for plan liabilities) should be adjusted for all multiemployer pension systems to reflect a more realistic valuation, such as a risk-free Treasury rate. The idea was that discounting plan liabilities at the return on asset assumption (ROA) had habitually underfunded these plans and forced asset allocations into more risky investments. That may be true, but to force plans to adopt this accounting of liabilities at this time for these mature plans makes no sense.

Employers and employees are already feeling the pinch of higher contribution expense. Dramatically reducing the discount rate would be an incredible burden and would likely lead to the eventual termination of the DB system. Just how profound would this impact be on the current universe of multiemployer systems? According to Ben Ablin, pension actuary for Horizon Actuarial Services and someone with whom I’ve shared the podium a couple of times at IFEBP events, produced a wonderful analysis that determined that all but 6% of the plans using FAS 715 rates would fall below 80% funded, while only 2% of plans would remain above 80% funded using a 30-year Treasury discount rate. More than 50% of multiemployer plans are >80% when using the plan’s ROA to discount liabilities.

As mentioned above, the impact on contributions would be crippling. In Ben’s analysis, he estimated that contribution expense would grow by 1.7 to 2.4Xs when using corporate discount rates and 2 to 3X when using the 30-year Treasury discount rate. If the goal is to drive these plans into the outstretched arms of the PBGC, you would likely accomplish your objective. Since that is not what most of us want to see, forcing plans to adopt a substantially lower discount rate in this environment is just not prudent.

This doesn’t mean that plans shouldn’t become more liability focused. They should look for opportunities to defease Retired Lives liabilities using their current fixed income exposure while managing the balance of the assets relative to future liability growth. This approach will help to stabilize the funded status and contribution expense as it relates to the piece that is being defeased. You have now bought time for the growth assets (non-defeased assets) to outperform your plan’s future liabilities. The bonds are now providing the cash flow, net of contributions, to meet the Retired Lives liabilities and are no longer considered performance assets, nor should they be, given the low-interest-rate environment.


2 thoughts on “Why It Makes No Sense

  1. Defease—this is quite the word! Is it an antonym of “bail out”? If the real purpose of a company (some will claim to serve the customer) is to make money, shouldn’t it be “spread” to “all” of the workers first, (including pension obligations) even if it “causes” bankruptcy? The real problem, in my opinion, is to spreading an inappropriate amount of the profits to the top executives and share holders, and not to all employees who have contributed to make those very profits! Make the companies PAY for their promises, not the taxpayers!

  2. Hey Tom – Good morning, and I hope that you had a great weekend. Defeasing the liabilities is an investment approach. It was the way that plans were managed when they were first brought to the market. It is a way to secure the benefit promises without incurring tremendous risk. The Butch Lewis Act requires that 1 of three de-risking strategies be employed with cash flow matching is the preferred implementation. The amount of the loan doesn’t change, but plan sponsors can’t play games with the asset allocation.

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