Legislation passed by Congress that changes how pension plan liabilities are calculated for funding purposes should translate into near-term relief for companies struggling with shortfalls, but won’t eradicate long-term shortfalls.
“While the new federal provisions reduce the amount of minimum required pension contributions, we believe such relief only postpones funding improvements and that companies are still on the hook for billions in underlying obligations,” according to Fitch Ratings.
The funding stabilization uses interest rates smoothed out over a 25-year period as a starting point for determining discount rates, with rates in 2012 limited to 90 percent of the 25-year average. Changing the discount rate, in the absence of other actions, only changes the present value of the liabilities, as future benefit payments are not changed, the company said.
“We believe that at some point lower current requirements will have to be made up by higher future contributions as investment returns (on a smaller base) are unlikely to offset shortfalls. In addition, we believe relief will not affect GAAP accounting for pensions and underfunding will actually expand with the lower contributions.”
Some companies have already announced that they intend to take advantage of lesser contributions, although sticking to lower targeted contributions is not mandatory. AK Steel said Monday it will cut 33 percent, or $100 million, of its pension contribution for 2013. Alcoa said it estimated a contribution savings of $100 million to $130 million this year and $225 million to $250 million next year. Sears Holding Corp. estimates its fiscal 2013 minimum required domestic pension contribution will be between $380 million and $430 million, down from the approximately $740 million estimated in its latest 10-K report.
Some companies may choose to skip the savings and contribute more than required to keep their plans well-funded.
Low interest rates continue to make it difficult for companies to keep their pensions fully funded, Fitch stated, but companies that find relief through the minimum required contributions will only reap even lower returns on investments because they have less invested. That will result in more long-term cash flow uncertainty and higher pension expense.