Pension reform risks - lipstick on a pig

Interest rates have fallen substantially which means that the aggressively high discounting rates for future liabilities for defined benefit pension will have to be reduced. If discount rates are reduced, companies will have to take more earnings and plow them into the pension plans to meet their obligations. If this happens, company profits decline. This could spell the end of defined benefit pension. Discounting is currently associated with the discount rate average over the last two years. The recent decline n rates is significant and will have a drag on corporate earnings.

However, there is pending legislation that may be signed into law that will allow the discount rate to be the average of the last 25 years. This will increase the discount rate by over two percent. By magic the new legislation will allow for less contributions into the pension plans because the discounted liabilities are less. Everyone wins with this magic! (Except for the workers when they want their pension and find that the money is not there.)

Pensions have moved away from equity and toward bonds. Pension plans have had 72 percent of their portfolio in equities in 2006 and not have about 52 percent last year. They are more dependent on the low interest rates in current bonds. The impact of these asset allocations may make pension more risky especially if the discount rate is higher. This a problem that will be have to be addressed but not now because of the discounting change.