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Pension Schmension



Steven Kandarian, executive director for the agency that did the projections, said he feared that by easing the demands on companies, the bill would put pension plans at risk. "These plans are already under funded by billions of dollars," he said. "This provision digs the hole even deeper, and weakens important protections that have been built into the system over the last 16 years."

The above quote comes from the NY Times this morning and was made by the federal agency, the Pension Guaranty Agency, responsible for ensuring the solvency of corporate pension plans. This same agency projects a corporate pension fund shortfall of $400 billion, but the problem is actually much worse.

Actuaries for companies know based on personnel statistics how much they will need and when to satisfy their obligations to retiring employees. But the two major assumptions (which can change everything) in making the final calculations are 1) at what interest rate will the current assets of the pension fund earn until these obligations are due and 2) at what interest rate should they discount the nominal obligation amount back at to reach a present value of those obligations.

Under current rules, companies are allowed to project whatever earn rate they want to use for their pension calculations. A high rate obviously makes the obligation less. Currently IBM is assuming they will earn 9% on their assets over the next 30 years. If we assume IBM's pension has an asset allocation of 60% equities and 40% bonds (bonds split 50% government and 50% corporate), that would mean IBM would have to earn 11% on equities compounded continuously over the next 30 years. The average compound rate of return (including dividends) for stocks over the last 30 years is somewhere between 7% and 9%. IBM's pension assets have earned nothing at best over the last five years.

Now the Senate Finance Committee is considering allowing corporations to discount the liability side of the equation back at a higher corporate rate versus the currently used government rate. Mathematically when we determine the present value of obligations, we always use the risk free rate (government bonds) adjusted for inflation (the real risk free rate is lower than the 30 year government bond rate). This is a far cry from what the government is proposing. To avoid a long theoretical discussion, suffice it to say that the new rules will allow corporations to be less conservative in their assumptions.

This does a great deal to alleviate the problems of the assumed obligations, but unfortunately not the actual obligations. All at the expense, by the way, of the pension fund beneficiary.

No positions in stocks mentioned.

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