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Testimony of Mark Warshawsky, Director of Retirement Research, Watson Wyatt Worldwide, presented to the House Committee on Ways and Means at the hearing “Defined Benefit Pension Plan Funding Levels and Investment Advice Rules,” Oct. 1, 2009.
Chairman Rangel, Ranking Member Camp and members of the Committee on Ways and Means, I appreciate the opportunity to present testimony on funding relief for single-employer defined benefit pension plans. The testimony represents the views of Watson Wyatt Worldwide, a global firm focused on providing human capital and financial management consulting services, doing business in the United States and in 32 other countries.
Although they have declined in importance over recent years as the primary retirement vehicle for active workers in the private sector in the United States, single-employer defined benefit pension plans still represent an important source of retirement benefits to millions of workers and retirees. They also are a significant financial responsibility for major employers. Moreover, as experienced in the recent financial meltdowns and market volatility, the main alternate retirement plan type — defined contribution such as 401(k) plans — did not perform so well in providing retirement security and peace-of-mind to retirees and workers, or, by preliminary indications, a smooth and orderly flow of retirements for employers.
If there is to be a good chance of a renewal of interest in defined benefit plans, for the mutual advantages of employers, workers, retirees, and society, it is important, at a minimum, that there be a supportive public policy environment for their continuation and creation. Perhaps of more immediate impact, at this sensitive time in the economic cycle, when weakness is still widespread, particularly in the job market, and the recovery, apparently, is just coming forth, we must be sensitive to the broad economic implications of the timing and amount of pension funding requirements.
From 2004 through 2006, I was Assistant Secretary for Economic Policy at the Treasury Department. Because of my long and extensive research background in retirement plans in prior positions, at the Federal Reserve Board, the IRS, and TIAA-CREF, I participated actively in the Bush Administration’s formulation of policies in this area, ultimately leading to the passage of the Pension Protection Act of 2006 (“PPA”). Although not perfect and somewhat incomplete, we believe that PPA is an important improvement over old law in many ways, in particular, to lead to fuller plan funding and more accurate measurement.
In the funding area, my modeling results indicate that, across many different economic circumstances, PPA would produce less volatile outcomes than old law.1 Old law was based on a knife-edge funding approach and Treasury bond yields which tended to go quite low in recessions, increasing pension liabilities somewhat artificially. Also, PPA provided plan sponsors with some of the tools and incentives to ultimately better manage their funding risks — either to go with a liability-directed investment approach, and smaller exposure to equities, or to build an asset cushion, to reduce the need to make sudden large contributions and pay increased PBGC premiums. These are good ideas and in more normal times will improve benefit security for workers and retirees, and also reduce risk exposure at the federal guaranty agency, the PBGC.
Yet, at the exact time that the somewhat stricter funding regime of PPA was coming on line, we experienced an almost unprecedented financial meltdown and deep recession. If the financial troubles had come later, I believe that corporate plans would likely have been in a better position — with new investment policies or perhaps larger asset cushions. But the timing could hardly have been worse, and huge funding contributions would have been required when corporate cash flows were low and capital markets closed.
So it was appropriate and timely, that Congress passed, last year, on a bipartisan basis, the Worker, Retiree and Employer Recovery Act of 2008, and that the IRS and Treasury provided this year some pieces of guidance that reduced the funding burden for the 2009 plan year. Our estimate (for details, see “Funding for DB Pension Plans in 2010 and 2011 Under Relief Proposals”) is that for the 2008 plan year, the average regulatory funded status was about 96 percent and required funding payments for all single-employer defined benefit plans just under $40 billion. With no changes, the average funded status would have declined to 75 percent and required funding payments increased to around $110 billion for the 2009 plan year. Because of the combined legislative and regulatory relief through September 25, 2009, we now estimate that the average funded status will be nearly 94 percent and required funding payments about $32 billion for the 2009 plan year. That required contributions will decline in 2009 from 2008 is a good result for the economy, giving plan sponsors some breathing room.
But the 2010 plan year is upon us, and corporate plan sponsors, with their long planning and budgeting horizons, are considering its implications. Our estimate, even with some recovery in the stock market thus far this year, is that the average funding status will decline to 84 percent and required funding payments increase to almost $90 billion in 2010, under current law and regulations. And the 2011 plan year looks worse, even assuming positive returns in the stock and bond markets, as funding status is projected to decline to 77 percent and required funding payments to increase to $146 billion, a heavy burden by any measure and consideration.
So it is again appropriate and important that Congress is considering further relief. We have modeled three legislative proposals — Representative Miller’s bill approved by the Education and Labor Committee, key aspects of Representative Pomeroy’s bill circulated in draft discussion form, and House Minority Leader Representative Boehner’s bill. Although they employ different technical mechanisms, each of the bills would reduce required funding payments somewhat in both 2010 and 2011 plan years. Representative Boehner’s bill would also reduce 2009 funding payments significantly, while Representative Pomeroy’s approach would increase them somewhat. The funding status of plans would improve significantly in 2009 under Representatives Pomeroy’s and Boehner’s bills, but would not change much thereafter in any of the bills.
More specifically, our estimate is that under the Education and Labor Committee bill, funding payments would be $30 billion for the 2009 plan year, $71 billion for 2010, and $130 billion for 2011. Under Representative Pomeroy’s approach, funding payments would be $41 billion in 2009, $79 billion in 2010, and $121 billion in 2011. Under Representative Boehner’s bill, funding payments would be $10 billion in 2009, $71 billion in 2010, and $125 billion in 2011. Over the three years, Representative Boehner’s bill gives the most relief, but the overall approach in all three bills of increasing the requirements over time is reasonable. I should note that these estimates are based on a particular assumed set of future asset returns and interest rates; with more time, we could produce estimates for a few other sets to determine sensitivity to different economic conditions.
As a simple suggestion, in the spirit of all three bills, but with the intent to give more relief, a cap could be imposed on current law required funding payments of increasing percentages of the 2009 required contributions for the 2010 and 2011 plan years, respectively.
Because of its many features, we did not model all of the provisions of Representative Pomeroy’s draft discussion bill. For example, his bill would offer employers an alternative amortization approach of funding recent shortfalls over 15 years, a good idea. But the maintenance of effort provisions contained in the bill represent a tricky challenge to modelers because we do not know whether they would cause plan sponsors to pass on the funding relief to avoid the burdens and intrusions of the retirement plan benefit requirements. More fundamentally, it is an open question whether the twin purposes of temporary economic relief for plan sponsors and governmental support of defined benefit plans are well-served by the maintenance of effort provisions.
If other than temporary narrowly drawn provisions are to be considered now, a supportive stance to consider to encourage full and ample funding for defined benefit plans in the long run and to discourage freezes and closes would be to reform the punitive asset reversion tax, with due protections for plan participants and the PBGC, as I have proposed and modeled elsewhere.2 In a more administrative vein, it would help policymakers and budget experts if the PBGC’s financial statements and projections used the law’s corporate bond market yield curve in valuing pension liabilities rather than a survey of group annuity prices that cannot be audited.
In closing, we believe that further legislative relief for single-employer defined benefit pension plans is good economic and retirement plan policy. In particular, we want to emphasize that funding relief is not just a pension issue, but with cash flows still tight and borrowing difficult, for many plan sponsors it is a matter of jobs and even survival.
I would be happy to answer your questions. On behalf of Watson Wyatt Worldwide, I also offer our technical assistance to the Committee if you decide to pursue funding relief. In that regard, the Committee acting quickly and positively to this important issue on a bipartisan basis would send the most positive signal to the plan sponsor community.
Gaobo Pang and Brendan McFarland of the Research and Innovation Center at Watson Wyatt Worldwide provided valuable input in helping to prepare the analyses upon which most of this testimony is based.
1 See Mark J. Warshawsky, “The New Pension Law and Defined Benefit Plans: A Surprisingly Good Match,” Journal of Pension Benefits, Spring 2007, 14(3), pp. 14-27.
2 See Gaobo Pang and Mark Warshawsky, “Reform of the tax on reversions of excess pension assets,” Journal of Pension Economics and Finance, 2009, 8(1), pp. 107-30.
October 2009
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