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Fletcher: Complex pension funding

July 10, 2012
Stephen Fletcher , The Alpena News

In my corporate life there is nothing more complicated than pensions. You have to fund them now, pay them later and use assumptions that change annually affecting a multi-year investment. In order to help, the government makes ever-changing rules to govern an employer's behavior concerning these investments.

An employer's allies are actuaries, who are guys and gals figure out just what your obligations are to the pension plan, and insurance companies and banks with close links to Wall Street hustlers. More of the army are accountants, who closely resemble the actuaries and attorneys who are more like the Wall Street guys.

The government representatives are from the Pension Guarantee Board and the Internal Revenue Service. These are you friends in this pension undertaking. Is it any wonder that everyone is switching to 401(k)s ?

There are three major numbers used to determine the value of a pension plan and its viability. Since pensions are funded on an annual basis for a project of future benefits, even seemingly small changes in the associated numbers may create large funding differences.

The three numbers relate to expected increases in wages, expected earnings rates for the existing and future fund assets, and the discount rate used to find the future value of the funds to determine if there will be enough money in the fund at the time of retirements to pay the obligations promised.

If the expected wage increases are high then the amount of money needed to fund the retirements goes up. Retirement benefits are usually calculated off of the expected wages at the time of separation. We often talk about the last year's earnings or a modification of those earnings to something like "the best three of the last five years."

The earnings rate just follows the markets actual experience and so it fluctuates with the bond and stock markets. If you have great earning then the amount of money needed to fund the pension goes down and less earnings mean greater funding is needed.

The discount rate fluctuates with the bond market and the lower it goes, the more money must go into the pension annually. The opposite is also true, but, with quantitative easing, the bond rates are close to zero.

Hugh Wynne of Sanford C. Bernstein & Co LLC said in 2009: "Lower discount rates are now expected to aggravate the adverse earnings impact caused by the loss in the value of pension assets last year." He could say exactly the same thing this year. He further said the change in the discount rate was due to the large change in the interest rates on long-term corporate bonds, which is also the same as it was then.

All of the lowering of the discount rate means more current funding is necessary to keep pension funds afloat in these perilous economic times.

With bonds down in yield and the stock market much lower than just a few years ago, the earnings generated by the existing assets in the pension plans also are eroding. The only bright spot for the pension plans is wages are not rising as fast as they were a few years ago.

What all of this means is that at our company, the plan assets are fairly level but the contribution to the plan must increase due to less earnings in the plan and the discount rate falling from 7 percent just a few years ago to 4.6 percent today. How much does it increase?

The increase in funding is about 250 percent to stay fairly even, but we are considering a larger contribution to get the funding level back up to where is would be more comfortable. Low interest rates and a lackluster stock market are killing our pension plan. We alert to it but not anxious at this point. To avoid anxiety we are funding more than the minimum recommended for this year.

Not too surprisingly, we are very careful about the pension at our utility. I say it's not surprising because most utilities are pretty conservative because we take a very long view of economic concerns as we are apt to be pretty much in the same business tomorrow as we are in today. So, high discount rates equal liberal and low discount rates equal conservative.

Here's another not too surprising fact. Municipal accounting for pensions is different than corporate accounting. Now that's probably as new to you as the fact that Congress doesn't use Social Security as its pension plan but has a better one than they offer to us.

The City of Alpena uses a 7 percent discount rate, which is much more aggressive than the one corporations must use and, as a consequence, overstates its funding assets relative to corporate standards. It is entirely within the law but it's good to know its funding compared to corporate standards is overstated by probably more than 30 percent. The previous administration did nothing wrong when it accepted the discount rate assumption. However, if the city were a corporation, its pension would be much less funded than the 90 percent rate which they are now enjoying because of government rules differing between municipalities and corporations.

In short, the federal shenanigans with the economy has not only caused the earnings of the average family to drop by $300 annually, they are imperiling your pensions.



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