Some Musings on Funding Relief
Congress has been considering extending funding relief to sponsors of defined benefit plans.There has been controversy about the conditions under which a sponsor will be eligible for relief. The two issues that loom largest in the controversy department are whether frozen plans should be provided with more limited relief than on-going plans and whether there should be limits on relief when a plan sponsor uses firm resources to make large payments to shareholders (whether extraordinary dividends or stock buybacks). The arguments relating to these two issues (on both sides of the issues) have been reasonably aired and in this blog I want to raise a few other ideas/questions (but since this is a sort of free-association posting, I may wind up saying a few things about those two issues as well—but no promises here.) Also, my comments will relate only to the single-employer setting.
(I also want to thank a friend, whose identity I will not reveal for a number of reasons, for commenting on this blog in advance. The friend said that the ideas were utterly wrong-headed but nevertheless provocative and thus perfect for a blog.)
1. The shape that funding relief takes should bear some relationship for the justification for the relief. So what is the justification for the relief?
1) Plan sponsors are under a lot of financial stress and relief is needed to save jobs. Here it is assumed that plan sponsors have this unhappy choice: make required plans contributions and lay off employees or retain employees and not make contributions. But if this is the justification for relief, relief should only be available to those plan sponsors who will in fact have to lay off employees if they are required to make full contributions to the plan. Should plan sponsors perhaps have to prove that they are in such a situation? And if relief is in fact limited to such plan sponsors, there is a bit of an irony, since presumably the plan sponsors that will have to lay off employees if not relieved of some funding obligations are probably the plan sponsors in the most precarious financial situations and thus the ones least likely to survive financially and ultimately bring their plans up to a responsible level of funding.
2) All employers have been hurt by the current economic situation and relief is thus appropriate even if the relief will not be used to create new jobs. But isn’t this just a way of saying that pension funding obligations are less important than any other use that the plan sponsor has for money?
3) The Pension Protection Act, which moved our funding rules closer to a mark-to-market approach and thus created greater volatility in annual contribution obligations, was a mistake. Funding relief is a second-best but possibly only available current response to the excesses of the PPA rules, since revisiting those rules may be politically impossible at the moment and in any event revising them probably should be a thoughtful, longer-term legislative enterprise. One of the questions I have here is how much better things would have been for plan sponsors if the PPA had never been enacted? We sometimes overlook that PPA increased the interest rate we use to value plan liabilities and that plan sponsors have already been extended some funding accommodations since PPA’s enactment.
Add to the mix a fourth justification for funding relief, which has been raised by some consumer and labor groups: funding relief is justified as a means of supporting active defined benefit plans, which are a partnership between plan sponsor and current employees. The employers who have stuck by their plans deserve this help. But here, funding relief would be reserved for employers with active plans only.
2. The Wall Street Journal a few weeks back reported that many large companies are holding large amounts of cash. (“With Fistfuls of Cash, Firms on Hunt,” March 4, 2010.) What is the justification for extending funding relief to these companies? Would companies that are sitting on cash be better or worse if they contributed some of that cash to their pension plan? I suppose this has something to do with a comparison between likely rates of return in the plan and after-tax rates of return outside the plan. Will hoarding cash rather than making plan contributions help a firm’s credit rating? Is it a hedge against a tight future credit market?
3. Some have argued that funding relief will not harm plans: it defers but does not excuse plan funding.
4. Isn’t it possible that a company will use freed-up cash to engage in mergers (that will result in some job loss) or move some operations (and jobs) overseas? (See Justification 1) in Point 1 above.) Hey, would that be ironic or what?
5. Should we revisit the PPA funding rules? And if so, when?
6. The Senate bill’s restrictions on shareholder payments allow payments up to EBITDA, which backs out depreciation, amortization, interest payments, and taxes from a financial accounting approach to income. This definition of income will create lots of artificial income for highly-leveraged firms, which would allow such firms to make larger payments to shareholders than firms with no debt. This doesn’t make much sense and may allow owners of a highly leveraged firm to strip out assets through shareholder payments, ultimately leaving the company and the plan high and dry. Should current earnings and profits under IRC section 312 be the appropriate benchmark for defining income for purposes of putting some governor on excessive shareholder payments for plans that choose to use funding relief?
7. How has the market recovery affected the case for funding relief and if so how? Plans are in better shape and thus their sponsors do not need funding relief as much as they did a year back. But because plans are in better shape, they are also less likely to fail, so funding relief is somewhat less risky now than it was a year back.
8. Money contributed to plans will be invested in the economy and allocated through the capital markets. Isn't that a better way of allocating capital than in effect providing unsecured loans to any company that happens to have a defined benefit plan In the long run, won't allowing market allocations of capital create more jobs than funding relief? This may be especially so given reports that the credit markets have been especially tight for start-up firms, which a prime engine for job creation.(But maybe preserving jobs in the short-run is more important at the moment than creating new jobs in the future. But will funding relief preserve many jobs? That is not clear. Again, see Justification 1) in Point 1 above.)