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WASHINGTON—Employers would be allowed to use higher interest rates in valuing pension liabilities, cutting employers' defined benefit plan contributions by billions of dollars over the next few years under legislation passed by the Senate on Wednesday.
The pension interest rate provisions are part of the broader highway funding bill, S. 1813, senators approved on a 74-22 vote.
The interest rate provisions were welcomed by pension lobbyists and others who have working for months to convince lawmakers that the extraordinarily low interest rates employers now must use under current law to value pension plan liabilities is forcing them to contribute to their plans far more than is necessary, depriving them of cash they otherwise could use to expand their businesses.
“These artificially low interest rates make healthy pension funds appear less well-funded than they truly are, triggering abnormally high pension liabilities. This, in turn, sends mandatory employer contributions to defined benefit plans soaring—greatly limiting companies' ability to invest in jobs and other capital improvements,” James Klein, president of the Washington-based American Benefits Council, said in a statement.
The legislation “will provide immediate contribution relief,” added Steve McGivney, a principal with PricewaterhouseCoopers L.L.P. in New York.
Under the legislation, as under current law, employers would continue to value plan liabilities based on interest rates on top-rated corporate bonds for three different segments, averaged over 24 months. Segments refer to when benefits are paid to plan participants.
Under this methodology, interest rates on bonds with maturities of up to five years are used to value pension benefits that will be paid within the next five years, while interest rates on bonds with longer maturities are used to value pension benefits paid over the next five to 20 years and pension benefits paid after 20 years.
The actual interest rate for each segment in 2012 would have to be within 10% of the average of those segment rates for the 25-year period preceding the current year. In succeeding years, this so-called 10% corridor would gradually increase and top out at 30% in 2016.
Using this methodology would currently push up the interest rate used to value benefits paid over the next five years by roughly three percentage points, with smaller, though still significant, percentage increases for benefits paid out beyond five years, experts say.
For example, the current required interest rate of nearly 2% to value benefit payments within the next five years would rise to just over 5% under the legislation, experts say. That would reduce the value of the liabilities and the amount employers have to contribute to their plans.
The measure now goes to the House of Representatives, with the chances of favorable House action significantly increased by the largely bipartisan Senate action, according to observers.
The fact that the Senate has passed the bill by a substantial margin “improves the odds of the House acting,” said Frank McArdle, a principal with Aon Hewitt in Washington.