Geithner supports “targeted” funding relief

Funding relief is desperately needed, but it is only a short term fix while we need deep structural pension reform in the US. The current (re)funding crisis in the US is a result of contradicting pension regulations that punish pension plans for being underfunded as well as being or becoming overfunded. Because of the reversion tax on excess pension assets and because of the non-deductibility of excess contributions, plan sponsors have no incentive to overfund their plans. Substantial overfunding in good economic times, however, is necessary if plan sponsors want to pursue risky investment strategies with higher expected returns. The introduction of the reversion tax in 1985, for instance, effectively changed the ownership structure of excess pension assets and led to trapped excess capital. Advised by consultants, plan sponsors then adopted minimum funding policies and took contribution holidays whenever possible. This directly increased long-term funding costs. Plan sponsors have faced a typical time inconsistency problem: Short term tax optimization contradicted their long term interests of sufficiently funding their plans to weather bad times. Funding deficits, on the other hand, are exacerbated by ongoing benefit payments and prolonged by the simultaneous deterioration of business conditions and refunding ability. This leads to a saw tooth behavior of funding levels over time. With funding levels capped on the upside, average funding levels over time are well below 100%. Yet whether an eventual equity risk premium can be turned into lower funding costs crucially depends on whether the average funding levels of the risky investment strategy are similar to those of lower returning, but safer investment strategies. So with its patchwork of pension regulations, Congress basically killed the viability of equities in DB pension plans. Unfortunately, no has noticed that and the current funding crises is the logical result of failed investment policies. Without deep structural reform, DB pensions will be sooner or later be a relict of the past. Tax regulations made them non-competitive with other retirement vehicles and plan sponsors reacted accordingly. However, it is also their and their consultants fault to not have realized that under these pension regulations, the recommended and implemented investment strategies were bound to fail in the long run. Most likely we will face at least one if not more recessions and/or financial crises over a 15 year time horizon, let alone a 30 year amortization period. Thus, any bill that stretches funding relief over such a substantial time horizon also needs to mandate substantial risk reduction in the implemented investment strategies, otherwise plan sponsors will find themselves in a similar if not worse funding situation in the future.