Tougher pension rules will strengthen the system

IS THE NEW PENSION funding reform law accelerating the demise of defined benefit plans?

One could come-erroneously, in our view-to that conclusion from recent events. Since Congress passed the legislation last month, about half a dozen companies, including Alliant Techsystems Inc., a big defense contractor, and Tenneco Inc., a large auto parts manufacturer, have announced that they are phasing out their defined benefit pension plans.

That those freezes came at the time the legislation was passed was coincidental. Corporations typically reach decisions regarding the funding, design and future of their pension plans only after months-in some cases, years-of analysis.

There is no question, however, that some companies, looking at some basic requirements of the new law-benefit promises will have to be funded faster and the ability to use certain gimmicks to put off funding is curbed-will decide to phase out their plans.

We don't find that especially startling or disturbing. Indeed, under the old loophole-ridden system-where employers could legally amass huge liabilities in their pension plans and not come close to funding what they promised-hundreds, if not thousands, of employers decided to freeze their plans.

Those corporate decisions, be they right or wrong, have not been based on whether funding rules are tough or weak. Rather, almost without exception, companies have said they no longer want to be exposed to the financial risk and volatility that is part and parcel of sponsoring a defined benefit plan. How much companies have to contribute to those plans is a function of investment results and changes in interest rates and there is little predictability on those two variables.

Increasingly, risk-averse companies prefer the cost predictability of a defined contribution plan and changes in defined benefit plan funding rules will have little impact on that mindset. While the defined benefit plan system will continue to decline, we still believe the new, tougher rules will strengthen, not weaken, that system.

By requiring employers to fully fund their plans, the likelihood that a plan will have sufficient assets to pay promised benefits is greater. That is important not just to employees but also to employers with a defined benefit plan. The latter care because failed pension plans are taken over by the Pension Benefit Guaranty Corp., and it is employers, through premiums they pay the PBGC, that foot the bill for companies that promise more than they can afford. With tougher funding rules should come smaller PBGC losses and perhaps stability in PBGC premium rates, defusing one reason why employers are phasing out their pension plans.

It also should not be forgotten that the new law protects new cash balance plans from age discrimination suits. Employers by the hundreds flocked to those plans before legal uncertainties forced them to back off. With those uncertainties eliminated, thanks to Congress, the cash balance design once again will be an option for employers who want to continue to offer defined benefit plans.