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Nov. 29 — If Trump administration economic policies end up boosting inflation and interest rates, as investors and some economists seem to believe, defined benefit pension plan funding ratios stand to be strengthened.
Even so, it’s uncertain whether such policies would have the effect of significantly pushing up the number of employers terminating their pension plans.
Following the Nov. 8 election of Donald J. Trump and the Republican Party-controlled Congress, U.S. stock markets rallied to record highs and domestic bond markets dropped. Investors seemed to be signaling that they expected the new government’s economic policies, once implemented, to cause greater economic growth, leading to rising inflation and interest rates.
Higher interest rates would improve plan funding ratios by reducing plan liabilities.
“If long-term Treasury rates rise to 5 percent from the current rates hovering around 3 percent, the majority of plans will be fully funded and many plan sponsors will jump at the chance to terminate their plans,” Brian Donohue, partner with the actuarial consulting firm October Three in Chicago, told Bloomberg BNA.
“For every one percent rise in long-term rates, plan funding ratios improve by 10-20 percent,” he said.
Interest rates and plan terminations may not accelerate, however, as much as investors think. Nevertheless, pension plans are likely to continue looking for ways to free themselves from plan risks.
“The more likely scenario is that the new administration’s economic policies will result in a slow interest rate climb that keeps plan sponsors from implementing strategies to transfer the risks of their plans at a pace similar to the gradual pace they have kept since the 1990’s,” Joshua Gotbaum, guest scholar in economic studies at the Brookings Institution in Washington, told Bloomberg BNA.
Such risk transfer strategies include plan terminations, offering lump-sum payouts to plan participants and purchasing annuities from insurers that take on a plan’s pension obligations.
Gotbaum, who previously served as the director of the Pension Benefit Guaranty Corporation, said that Congress under the Trump administration is likely to enact a major tax cut bill that would be a significant fiscal stimulus to the U.S. economy.
However, he said other factors are likely to keep inflation low over the near-term.
The rest of the world is “economically a mess,” he explained. Foreign investors continue to see the U.S. Treasury as a safe haven for their surplus capital, he said. Thus, even if the fiscal stimulus resulting from a tax cut puts pressure on interest rates to rise, foreign investors’ demand for U.S. Treasuries will likely keep interest rates lower than they otherwise would be, he said.
In addition, Trump’s anticipated tax cut will likely provide the biggest benefit to high-income taxpayers who have more surplus cash, Gotbaum said. Such taxpayers are more likely than lower-income earners to save their tax cut benefit than to spend it. This will serve to dampen the effect of the fiscal stimulus on the economy and on inflation, he said.
Trump’s plan for a massive infrastructure bill could also be an economic stimulus if it were enacted without corresponding spending cuts from other parts of the federal budget.
Such a plan would be beneficial, Gotbaum said, but would take years before it could fully affect the economy or interest rates.
Even with these possible changes, single-employer plan sponsors will continue to implement strategies to transfer their plan investment and interest rate risks, Gotbaum said.
He said one of the more popular transfer risk strategies will continue to be the offering of lump-sum pension options to employees in place of a lifetime annuity payout. The Treasury Department, by postponing at least until 2018 the release of its updated mortality tables, has made lump sums more attractive for plans to offer than purchasing annuities, Gotbaum said. “It’s unfortunate that Treasury has chosen to encourage de-risking in the worst possible way for retirement security,” he said.
While insurers have raised group annuity prices for plan sponsors to reflect longer life expectancies, employers can still use the outdated and shorter life expectancies of existing mortality tables in determining lump sums, making such distributions a relative bargain for them, Gotbaum said.
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