Problems with pensions

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Stocks' lackluster performance has caused significant collateral damage to pension plans. The shortfall in the $1.6 trillion pension industry could deeply affect not only the roughly 44 million pensioners in line to receive defined benefits, but also any investor with stock and bond holdings, and the federal insurance agency that guarantees the pensions, the Pension Benefit Guaranty Corp. (PBGC).

Given these problems, the Bush administration and lawmakers have proposed new rules for pension plans. Policy-makers face this quandary: how to shore up pension portfolios' quality and risk exposure without affecting the market performance the funds also depend on. If new rules are too extreme, pension plans may have to replace some stocks with bonds, marring a budding market recovery. The administration has put forward a proposal geared to nudge pensions towards greater security, without triggering asset sales that would pummel markets at a delicate time. We think it makes sense.

Currently, defined-benefit pension plans are more than $300 billion in the hole, compared to about $23 billion four years ago, before the downturn in the stock market. The PBGC in the past has been able to pay its obligations through its collected premiums, but its promises now exceed assets by $5.4 billion, and more obligations are coming.

The administration's proposal seeks to bolster plans' solvency by gradually stiffening the rules. The proposal would allow pension managers to assume, over the next two years, that their portfolios would grow at an index of corporate bond rates, which was 5.3 percent in June. This rate is higher than the current assumed rate (known as the discount rate) of 4.4 percent in June for 30-year Treasuries. A higher assumed rate of return would allow corporations to make lower contributions.

After those two years, the plan would put pension funds on a sliding scale of rates. The rate on 30-year bonds would be applied to contributions for pension payments not due for another 30 years. Contributions for obligations due in five years would get a five-year bond rate, and so on.

Also, the plan calls for a changes in pension fund accounting, requiring managers to discontinue the current practice of averaging out the value of their funds over a four-year period, moving gradually to a 90-day average instead. Some analysts suggest this accounting practice could force pension funds to replace some stock holdings with more predictable bonds. The administration's plan would also bar corporations with heavy pension liabilities and insufficient assets from offering more defined benefits until they secure their current obligations.

Getting Congress to sign off on the administration's proposal may be tricky. Unions generally don't want tougher standards for pension plans, since they fear this may discourage companies from offering defined benefit plans. Many lawmakers are also reticent to put more requirements on corporations. The House Ways and Means Committee recently voted for dropping the current 30-year Treasury rate for a higher corporate bond rate over the next three years. The committee did not adopt the administration's recommended sliding-scale rate or new accounting rules.

The administration's plan strikes a strategic balance between improving the quality and transparency of pension plans, while insulating markets from upheaval while the economy recovers.