Congress Considers Provision to Alter Pension Obligations

On May 8, House and Senate conferees will meet to begin formal negotiations on a long-term transportation bill. The Senate passed a $109 billion highway bill in March, and in April, the House passed temporary legislation, which will serve as its basis for negotiations. The House bill includes a number of controversial provisions, including language approving the Canada-to-U.S. Keystone XL pipeline, which President Obama has threatened to veto. The current transportation authorization expires on June 30, placing pressure on conferees to produce an agreement before that date.

The Senate Highway Bill (S. 1813) includes a section titled “Pension Funding Stabilization,” a provision added as part of a manager's amendment introduced by Barbara Boxer (D-CA) and approved unanimously. The provision would alter private sector, single-employer contributions to defined-benefit pension plans by essentially smoothing out the discount rate over time.

The pension provision was included in the highway bill because it raises revenue for the federal government—the sponsors of the provision estimate it will raise $9.467 billion over 10 years. Allowing employers to base contributions on higher interest rates leads to lower pension obligations and therefore lower contributions, smaller corporate tax deductions, and ultimately more tax revenue for the federal government.

In defined-benefit pensions, the discount rate represents the expected return on investment and is used to calculate the present value of benefits. The lower the discount rate, the higher the liabilities and obligations by the employer. Proponents of the stabilization provision in the highway bill argue that because the Federal Reserve is “intentionally” keeping interest rates low, employers are facing abnormally high pension liabilities. They also assert that, with lower liabilities, more cash could be used for job creation, capital improvements, and other business investments, ultimately contributing to economic stimulation.

Opponents of the provision believe the Senate proposal is simply short-term relief and ultimately increases the risk of underfunding pension plans by ignoring current interest rates. Additionally, despite the ability to make smaller contributions now, future obligations do not go away, thereby shifting cash flow obligations to the future, adding pressure on the Pension Benefit Guaranty Corporation (PBGC), and potentially placing federal taxpayers on the hook for pension bailouts.

Currently, a two-year window is used in the discount-rate formula. The highway bill provision would extend the window, keeping the discount rate within 10% of an average of corporate bond rates over the preceding 25 years. Between 2012 and 2015, the 10% “corridor” would gradually expand to a 30% variant. The Senate Finance Committee explains, “Because there is an inverse relationship between the level of interest rates and the level of required contributions, as compared to current law, higher contributions will be made during periods of abnormally high interest rates and lower contributions will be made during periods of abnormally low interest rates.”

The outlook for this provision remaining in a final highway bill legislative package is unclear, just as the likelihood for an overall agreement remains murky. Given the significant differences between the Senate and the House versions of the highway bill, negotiations are likely to be difficult—especially in light of the current level of partisanship in Congress and the approach of Election Day. If conferees craft a package that requires significant levels of new spending on transportation priorities, the possibility of their including the pension stabilization provision increases because the provision is expected to raise revenue. If the provision is not ultimately part of the highway bill agreement, we may see efforts to include it in other legislative vehicles this year.