Why Pension Plans Are Underfunded

 

There’s been plenty of fear and loathing of corporate pension plans in the last few years, and with good reason: most of them have gone from overfunded to underfunded in the space of two years. That meant more cash hovered out of the corporate till, away from shareholders or projects that benefit shareholders, and increased possibilities that plans might actually fail.

Why did the plans go underfunded so quickly? Obvious reasons: a large portion of pension plan assets are invested in equities, which tanked from 2000 to 2002, and at the same time, interest rates declined, inflating the present value of pension plan obligations. The financial community blathered endlessly about that “perfect storm”, wrung its hands, wept and prayed. When the markets turned up again in 2003 and 2004, the Etch-A-Sketch was turned over, and the memory of the perfect storm’s punishment was erased.

The not-so-obvious – and more permanent – reason for underfunding: the ERISA and Internal Revenue Code rules requiring contributions to defined benefit plans have all the snarl and bite of Paris Hilton’s Chihuahua. That’s finding of the Government Accountability Office in its study entitled “Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules” (GAO-05-294).” It’s a study of the 100 largest plans in the United States, and I highly recommend that you read it if you want to understand why the system is pretty much rigged for funding failure when it comes to requiring adequate contributions to pension plans.

Most investors and analysts are familiar – or should be familiar – with the crazy exceptions built into the GAAP reporting of pension cost. For example, losses on assets and plan obligations can be deferred and amortized into cost after the accumulated amount of the losses reaches a 10% threshold, based …