Employers can reduce their contributions to employee pension plans this year thanks to a new federal law allowing them to assume higher interest rates in valuing the size of their defined benefit plan liabilities.
The bill President Barack Obama signed into law earlier this month does not include higher Pension Benefit Guaranty Corp. insurance premiums, which were boosted by similar legislation Congress approved two years ago and again by a measure passed last December.
The savings for employers will be significant, according to a Towers Watson analysis. Minimum required employer pension contributions this year for defined benefit plans with at least 1,000 participants will drop $17.2 billion to $44 billion because of the pension funding changes tucked into the Highway and Transportation Funding Act.
“This can't be described as anything but good news,” said Jim McHale, a principal at PricewaterhouseCoopers L.L.P. in New York.
Since the financial crisis in 2008 when interest rates and equities markets plunged, employers' pension plan funding levels sharply declined. The new law essentially gives companies more time to catch up on plan contributions. While pension funding levels have significantly improved in the last year because of the surge in the equities markets, many plans still are underfunded because current low interest rates have inflated the present value of plan liabilities.
The new law effectively will allow employers to use higher interest rates in valuing their pension liabilities. That, in turn, reduces the value of the liabilities and with that the contributions they are required to contribute to the plans.
The law does that by retaining through 2017 a formula—set in the 2012 law—that sets the interest rate used to calculate the value of plan liabilities.
For example, under the law, employers will be able to use an interest rate that is 90% of the rate—averaged over 25 years—of top-rated corporate bonds maturing over certain periods in calculating the value of plan liabilities. Without the change in law, the interest rate would have had to be 80% of that rate.
By continuing the 90% range in 2014, the interest rate employers can use to value pension plan liabilities will increase by 0.7%, and by 1% in 2015, according to Mercer L.L.C. estimates.
“In the short term, this will decrease minimum required plan contributions,” said Alan Glickstein, senior retirement consultant at Towers Watson & Co. in Dallas.
Whether employers take advantage of the extended funding relief will vary depending on their circumstances, and those contributing less now may have to pay in more later.
While “employers may have to pay more later, at least they have the flexibility over when to make these contributions,” said Bruce Cadenhead, chief pension actuary at Mercer in New York.
Despite the latest pension funding law, employer premiums paid to the Pension Benefit Guaranty Corp. still will increase because of legislation approved in 2012 and 2013.
Last year's legislation significantly boosted PBGC flat-rate premiums, which are paid by all defined benefit plan sponsors, to $57 per plan participant in 2015 and to $64 in 2016. The premium now is $49 per plan participant to the agency, which last year reported a $27.4 billion deficit in its insurance program guaranteeing benefits for participants in single-employer plans.
Benefits experts say a June report by the pension agency showing a shrinking deficit in the coming years may have defused congressional interest in making more premium increases.
The analysis projects the deficit in the single-employer insurance program would shrink to $7.6 billion by 2023.
“At least for now, there is less momentum for another premium increase,” said Eric Keener, a partner at Aon Hewitt in Norwalk, Connecticut.