In the debate over whether to extend unemployment benefits, Congress is considering using pension funding relief to help pay the cost. Extension of unemployment benefits may or may not be a good idea, but extension of pension relief certainly is.

Defined benefit pensions have faced tremendous pressure in recent years from the one-two punch of the Pension Protection Act (PPA) of 2006 and, more recently, historically low interest rates that were barely imaginable when that legislation was passed. The relief under consideration would alleviate some of that pressure, making plan sponsors less likely to shutter open schemes and raising revenue—all at the same time.

The PPA and related legislation required that corporations use a discount rate essentially equivalent to AA corporate bond levels to value their pension liabilities. The lower the rate, the higher the value of liabilities and underfunding. The law required corporations to amortize approximately one-seventh of their underfunding each year. The intensity of this funding pressure has caused many corporations to freeze or close their pensions.

But this outcome is not necessary: Pension liabilities never come due all at once. They are paid out over decades. To allow the snapshot of today’s interest rates to dictate the size of contributions holds corporations hostage to the lower interest rates of right-now. It creates a terrible mismatch of long term liabilities measured by rates frozen at any given moment. Using a smoothed discount rate reflecting the movement of interest rates over the decades during which the liabilities will be paid out makes far more sense.

The PPA was passed in the aftermath of the bankruptcy of Bethlehem Steel and other catastrophic failures. When Bethlehem Steel declared itself bust, many were shocked to see that the company’s pensions were less than 50% funded, even though it had complied with all legal requirements for pension funding. The Pension Benefit Guaranty Corporation (PBGC) was hit with a huge obligation that increased its long-term deficit by many billions of dollars.

When Congress passed the PPA, its focus was more on the health of the PBGC than on maintaining a robust defined benefit pension system. If every private sector pension plan were always fully funded, then the PBGC would never face another threat. But if every corporate pension plan were always fully funded, neither corporations nor pension recipients would gain the benefit of long-term investing that can reduce the cost of maintaining a pension. Such an onerous requirement will cause many companies to terminate their plans.

It would be wonderful if all corporations’ pensions were always fully funded. But imagine a healthy company that always maintains its pension at 80% funded. So long as that company is in operation and keeps its plan funded at that level, the investments can grow and the pension plan will always meet its obligations. That company poses little threat to the PBGC.

The threat to the PBCG does not come from underfunded pension plans. It comes from underfunded pension plans in companies that go bankrupt. By the time companies file for bankruptcy they have generally stopped funding their pensions anyway, regardless of legal requirements. In trying to protect the PBGC too much, Congress made maintain plans too difficult, expensive, and volatile, which is why so many have already closed.

In an ironic twist of only-in-Washington arithmetic, the change Congress is considering is counted as a revenue raiser. It was used two years ago to help pay for a transportation bill. That bill offered smoothing—but for only three years. It raised $9 billion in revenue. The current proposal to fund unemployment benefits would last for five years and, due to certain corridors in the relief, would raise about $6 billion. A permanent change would raise over $100 billion. In the near term, corporations would put less current funding in their plans. Less in near-term contributions equals less in near-term deductions, equals less in “tax expenditures,” and is therefore a revenue raiser.

However, lest anyone think this bodes ill for the long-term health of pensions, understand that when rates rise in the future, corporations would not receive complete relief by marking their liabilities way down. In fact, in flush times for pensions—good investment returns, higher interest rates, lower liabilities, better funded status—corporations could not take the funding holidays of the past. Rather, they would have a less volatile, more predictable obligation in good times and bad times.

Whether Congress uses those funds for extension of unemployment or another purpose is a different question. But a bill that makes maintaining pensions more attractive to corporations without reducing long-term funding obligations—and raising billions of dollars in the process—sounds like a clear winner even in today’s political climate.

Source: AI-CIO