One of the biggest problems that corporate America and the millions of employees who work in it face is figuring out how to provide for workers' retirement. Recently, pension plans have attracted increasing amounts of attention as companies look for solutions to deal with the worsening challenge of how to earn enough to meet pension commitments in an environment of poor investment returns. That challenge threatens not just workers' retirement prospects but also the financial survival of dozens of huge companies that have to provide for workers.
The federal government recently came to the rescue for corporate pensions, letting companies kick the can further down the road. Later in this article, I'll give you all the details. But first, let's take a look at the scope of the problem and why it's become such a contentious issue recently.
The problem with pensions
If you've ever tried to plan for your own retirement, then you can understand the position that corporate pensions are in. Pension plans own huge pools of investment assets, thanks to ongoing contributions from the companies that run them. But they have to balance the needs of thousands of current and former workers, some of whom receive income payments from the plans now, and others of whom may not need benefits for 30 years or more. As a result, they have to own investments that will both grow and produce income -- not something that has been easy to accomplish in recent years.
At the same time, though, pension plans have obvious financial implications for the companies that run them. Companies have to reduce earnings when they make contributions to pension plans, and because analysts and investors penalize companies when they miss earnings estimates, there's a big incentive to fund pension plans with less than enough money to pay the expected amount of future pension benefits.
One solution that major pension plans at General Motors
A bandage with no stick
But for companies that don't have the cash on hand to make such huge lump-sum payments, the federal government appears poised to help out. As Barron's reported over the weekend, the federal transportation bill that became law over the weekend included provisions that would allow companies to use higher interest rates to discount future obligations. That will cut the amount that those companies have to contribute to pension plans to be considered fully funded.
Yet this purported solution has two major flaws. The smaller one is that the impact of the move will be temporary. Because of the complicated way in which the new calculations incorporate both a two-year average and 25-year average of corporate bond rates, the impact of the provisions becomes smaller each year.
More important, though, using higher rates increases the likelihood that companies won't be able to deliver on the assumption underlying them: that investment returns will actually meet that target. That's certainly been a problem with public pensions, where discount rates of 7.5% to 8.5% are common despite the fact that their portfolios typically need to be fairly bond-heavy to accommodate current income needs.
The near-term effect
What stock investors need to know, though, is that lower pension obligations could goose up earnings in the short run for companies with struggling pensions. That's good news for Alcoa
Unfortunately, these new rules do nothing to address the true question of how companies will come up with enough money to support their workers in retirement. Without companies stepping up to the plate to live up to their obligations -- or at least giving workers a chance to make their own decision about one-time buyouts -- the worst for workers is yet to come.
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