May 19, 2013

How A Highway Spending Act Magically Made Private Pensions Healthier

My wife has a pension from a previous employer. Its not much of a benefit because the length of employment wasn't very long and she's many years away from retirement age.  But because she is vested in this small pension benefit she gets the pension plans annual funding notice.    The notice came in the mail recently.   In 2011 the plan was only funded about 80% and then in 2012 the funding went up to 100%.  

You'd think thats awesome right?   I assumed that the company must have done a great job with the plan assets or added funding to the plan to beef up its funding level.   Its now 'fully funded' and can pay its liabilities.  Great job.   Wait a second.   Reading past the funding liability table I see the statement said something about law changes and implementing changes from something called 'MAP-21'... yadda yadda... todays low interest rates... blah blah... allows the plan to use average interest rates over the past 25 year period... etc.    Hmmmm...   So whats that all mean?

First, what is MAP-21?

MAP-21 is the short hand name for the 'Moving Ahead for Progress in 21st Century Act'.   And that name really tells us nothing.  At least it beat out the marginally less popular 'Moving Back to the 18th Century Act'    The MAP-21 act is a transportation spending bill.   So whats that got to do with our pensions?    Well to pay for the highway bill they had to balance the books so they threw in a couple pension changes that actually raise tax revenues.  Bear with me...    The changes made it so that employers would have to put less money into their pensions and because the pension contributions are tax deductible that would result in higher tax revenues.   So naturally your pension is now better funded... If you aren't confused yet then you may have a career ahead of you in the D.C. area.  

OK So WHY is the Pension BETTER Funded?

The key provision in MAP-21 related to pension funding was a rule change that allows pension plans to use an average interest rate over the past 25 years instead of using current interest rates.

Todays interest rates are really really really low.  (If you hadn't noticed).    Pension plans have to figure out their future liability based on various assumptions and several variables and one of the major variables is the prevailing interest rate.     Say for example that you want to go buy an annuity from an insurance company today.   It will cost you more because interest rates are low.   For the same reason liabilities from pensions are higher when interest is lower.   (at least thats one way to explain it.)    In low interest rate environment the pensions look like they have higher liabilities because of the impact that interest has on the projections.   When interest rates are low the liabilities are higher and when interest rates are higher the liabilities are lower.  

Up until the MAP-21 rule change pensions were having to use todays very low prevailing interest rates (2 year average) and that made their projections worse.   With the MAP21 rule change they can now use an average interest rate from the past 25 years which is a higher interest rate.  Because the rule change makes liabilities lower the funding level goes up based on the same starting asset value.   Plugging in a higher interest rate into the actuary calculations for the pensions can result in the pension having a much higher funding level.

And don't forget that the federal government makes more money in taxes.   Its a win for everyone!  Your pension is better funded, the business has to put less money into the pension and the government makes more tax money.  Yay!  

Cynicism aside, I don't think this is a bad thing really.   In fact I think the change is pretty reasonable and makes more sense.   Its a little silly to base pension projections on the most recent 2 year average interest rate to begin with.  Pension liabilities last 20-30 years into the future and clearly the variables involve will fluctuate over 2-3 decades.  It makes a lot more sense to plan for a number that is a 25 year average if you're planning for a 25 year time horizon.

The Pension Rights Center covers the topic with their discussion of Pension Provisions in H.R. 4348 – Moving Ahead for Progress in the 21st Century (MAP-21) Act

The Society for Human Resource Management also explains it in their President Signs Pension Funding Relief Measure


Blog Widget by LinkWithin