To see this article in digital magazine format, click here.
“The Moving Ahead for Progress in the 21st Century Act (MAP-21) is a milestone for the US economy and the nation’s surface transportation program… transforming the policy and programmatic framework for investments to guide the system’s growth and development,” touts the website run by America’s Federal Highway Administration. What it doesn’t tout, however, is how MAP-21—ostensibly a highway funding bill that, not unimportantly, also alters how companies will fund their defined benefit pensions—came to pass in the back halls of a Congress mired in gridlock and partisan passion.
But Carol McFate knows. “Let’s go back and talk about the history,” McFate, CIO of Xerox Corporation and one of the key drivers in the creation of MAP-21, said one late October afternoon when I spoke with her by phone. “It’s a story that has so many twists and turns, it’s hard to keep straight.”
All throughout 2011, McFate said, corporate plans sponsors were “becoming increasingly concerned about the impact of various Fed actions—QE2, Operation Twist, and more—and the effect of these actions on the size of corporate pension liabilities. We, meaning Xerox, started to discuss potential reform in October 2011.”
And then Xerox joined forces with a strong partner: The American Benefits Council, who at the same time was focusing on the same problem. That same month, the Council published a brief—the somewhat awkwardly titled Raising Revenue and Saving Jobs by Resolving a Conflict Between Pension Policy and Economic Policy—arguing that “current-law requirements to amortize long-term liabilities over seven years have created unmanageable volatility in funding requirements.”
With a typical defined benefit pension plan, the Council argued in its brief, “the effective interest rate required by law has dropped by approximately 70 basis points over the past year, which increases liabilities by approximately 10%.” For a plan with $7 billion in liabilities—large, but not a mega-plan by any means—that would mean a liability increase to $7.7 billion. “This in turn triggers a company obligation to make an additional contribution of approximately $119 million per year for seven years,” the paper continued. “That $119 million is not needed to pay benefits; that obligation is simply the result of low interest rates that have no relationship to the plan’s ability to pay long-term benefits.”
“The paper basically urged Congress to adopt a policy where any segment rate used in determining pension liability be within 10% of the preceding 25-year average,” McFate said. “In plain English, pension liabilities are based on a rolling two-year average of high-quality corporate bonds, but if these prices are way out of line with historical averages, plan sponsors shouldn’t be held to that.” The reasoning is simple, and well understood: Pensions are highly exposed to short-term interest rate changes, while at the same time being very-long term in how they pay out benefits. This proposal, according to the American Benefit Council paper, “will ensure that temporary fluctuations in interest rates do not have an unjustified effect on funding obligations.”
The idea quickly (by Washington standards) gained traction. “Once we had this framework, Xerox Government Affairs staff and their colleagues at other plan sponsors formed a coalition of more than 200 businesses and trade associations focused on the issue. They met with Democratic and GOP staff on the Senate Finance and HELP committees, as well as the House Ways and Means and House Education and Workforce committees,” she said. “By March, the Senate Finance committee, both Democrats and Republicans, adopted our proposal with one key change: the 10% collar phases out over five years, eventually resetting to current law.” In essence, the impact of this smoothing would only be temporary.
But how did such a bill pass through the clogged arteries of Washington, you ask? Our best answer is: through a unique compromise that brings to mind the oft-repeated phrase that legislation is like making sausage.
“It was then included in the highway bill, because it theoretically raises revenue,” McFate said. “The idea is that if companies are given some relief from topping up their pensions, they will have more profit, and thus pay more taxes. The federal government will receive more revenue—which will offset the cost of the infrastructure spending,” which the Highway Administration claims will be upward of $100 billion over fiscal years 2013 and 2014. “For several months, the House and Senate went back and forth about the differences in their versions of the highway bill, but it was finally passed—with the 10% corridor phasing out after five years—in June this past summer.” The end result: Plan sponsors will likely feel some relief, as interest rates remain super-low—and their projected liabilities remain sky-high.
“Is this the relief they were hoping for?” McFate mused. “We view it as a positive outcome. However, we are living in an interesting environment where rates continue to be very low. From what the Fed has communicated, they could keep rates low for an extensive period of time. MAP-21’s helpful in the near-time—however, if we don’t see rates starting to normalize by the time the benefit abates, well…”
The plan, of course, had some opposition—not so much from within the halls of power, but from outside. “There was a group of actuaries out there saying that this was not constructive—their idea was that plan sponsors should live and die by real rates—but I think that is a somewhat narrow view. You have to look at it in a broader context. Companies want to do the right thing, and this isn’t some clandestine plan where companies are looking to shortchange their participants. It just makes sense, based on the length of these liabilities and the impact of short-term rates,” McFate said.
Whatever way you look at MAP-21, it is a form of bipartisanship—and a form of an even more fleeting Washington idea: compromise. The making of the sausage is never pretty, but in this case, at least, it got made. Perhaps it is a caricature of their sacred cows, but Democrats were willing to allow corporations some relief, and Republicans were willing to spend money on public works. Maybe there is hope for Washington yet.
