US - Stock market declines are expected to force US companies to contribute billions of dollars into their pension plans in the next several years to address funding shortfalls and comply with federal laws that protect workers' pensions.
Only about 15% of employers made pension plan contributions in 2000, and that number increased to about 25% in 2001, according to research by Watson Wyatt.
For the current year, Watson Wyatt estimates that about 30% of the plans will require contributions and, if current market conditions persist, that number could more than double to 65% in 2003.
Meanwhile, as asset values have declined, liabilities have soared and fewer companies have sufficient funds to fully cover their pension liabilities.
In fact, Watson Wyatt research shows that only about 40% of pension plans had assets in excess of plan liabilities as of 1 January 2002, down from about 85% in 2000. If current economic conditions persist, it is likely that only about one fifth of plans will have sufficient funds to fully cover liabilities in 2003.
“Pension funding laws were originally developed to allow employers to budget pension contributions over time with flexibility, so they could fund more in good times and less in bad times, said Kevin Wagner, a retirement practice director with Watson Wyatt.
But with numerous changes to funding rules over the past 15 years, today's laws have precisely the opposite effect.”
Current law requires an annual comparison of a plan’s current liability with its valuation assets. Simply stated, if the ratio falls below 0.9 the plan may be subject to additional minimum funding requirements above and beyond “normal” funding requirements, but if the ratio exceeds 1.0, plan contributions may not be deductible.
Because of this relatively narrow range, contributions can be very volatile from year to year. With the recent market declines, many plans went from a situation where contributions were not deductible to a situation where significant contributions had to be made.
“The bottom line is that if employers aren't given more flexibility in terms of when they can or can’t make pension plan contributions, they won't sponsor these plans,” noted Wagner.
“Without orderly funding, employers have difficulty managing other important costs, including pay budgets and technology investments. And ultimately, this hurts employees the most.”
Wagner also notes that the volatility associated with pension funding encourages plan sponsors to invest more heavily in fixed-income securities than they otherwise might.
“A 100% fixed income asset allocation is likely to provide lower investment returns, but it allows employers to control the volatility of pension contributions and more accurately budget over time.
“Unfortunately, employees pay the price for these foregone investment returns in the form of lower benefits in the long run.”
To smooth the pension funding process, Watson Wyatt proposes that an employer’s current liability be determined based on interest rates in effect as of the date of the plan's valuation rather than on the current liability based on a four-year weighted average of 30-year Treasuries.
“This measurement represents a much more accurate measure of the plans' funded status at the valuation date,” said Wagner.
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