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October 01, 2003
Pension Underfunding Still Widespread, Yet...
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erfunding in corporate pension plans is widespread but perhaps not as troublesome as recent reports suggest, according to an analysis by HR consultant Watson Wyatt Worldwide.

The study found that while almost two-thirds of the nation’s 1,000 largest companies have underfunded pension plans, the ratio of unfunded pension obligations to total corporate assets is less than 4 percent for the typical large plan.

"Relative to total corporate assets, the unfunded pension liabilities of most large companies are not excessive," says Sylvester Schieber, director of research at Watson Wyatt. "Unfunded liabilities should always be monitored. But the real problem with the pension system is a regulatory environment that actively discourages not only the full funding of future liabilities but the very idea of pension plan sponsorship at all."

Indeed, primarily due to terminations, the number of defined benefit pension plans has declined by about 20 percent in the past three years, according to government data.

Economic and regulatory forces batter pensions. Record low interest rates, declining stock markets and corporate operating losses have combined to create the worst environment for pension plan funding since the passage of the Employee Retirement Income Security Act in 1974, according to Watson Wyatt.

According to a Watson Wyatt survey of 472 plans with 1,000 or more participants, the percentage of fully funded pension plans declined from 84 percent in 1998 to 37 percent in 2002. Yet the situation was much worse after the passage of ERISA. In 1978, the number of fully funded plans was only 25 percent, but by 1985 that number soared to 78 percent.

"This suggests that today’s underfunding can be resolved," says Schieber. "However, in the mid-1980s, Congress curtailed tax incentives for pensions, placed new limits on funding and set up other restrictions. As a result, a new round of underfunding began showing up in earnest in the 1990s, although it was masked by the economic boom of the period."

According to Schieber, these short-sighted regulations and historically low 30-year Treasury bond rates – which determine funding requirements – have already played a significant role in the demise of many pension plans. In an attempt to find a replacement for the 30-year Treasury rate, the Senate Finance Committee has recently approved a proposal to use a bond yield curve to calculate pension liabilities. However, the outlook for this proposal is unclear as competing proposals are being considered.

Cash call of about $80 billion this year and next. During 1999, Fortune 1000 companies contributed $11 billion to their defined benefit plans. By 2002, this number soared to $44 billion. Despite this infusion of dollars – more cash than had been contributed over the previous three years combined – plan funding continues to deteriorate.

Watson Wyatt research shows that Fortune 1000 plan sponsors with underfunded plans will contribute at least $83 billion to their plans this year. Even assuming annual returns of 8 percent this year and next, these same employers would have to contribute roughly another $80 billion for 2004 if current law is not changed.

"Growing costs have undoubtedly contributed to the demise of some plans," says Schieber. "But recent plan curtailments will likely pale in comparison to future terminations if the remaining plans have to face the cash call that current law portends. Unfortunately, without changes, the worst may be yet to come."

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