Sober Look — Kicking the pension can down the road

Tucked away in the transportation bill passed almost two years ago is a small provision that has little to do with transportation. The bill is called Moving Ahead for Progress in the 21st Century Act or MAP-21 and buried deep within it is a law that deals with defined benefits corporate pension plans.

... MAP-21 modified the method for determining the interest rates used to determine the actuarial value of benefits earned under the plan, providing for a 25-year average of interest rates to be taken into account in addition to a 2-year average ... 

For those of us who grew up on the concept of "discounted cashflows" this law is particularly absurd. The basics of finance tell us that the net worth of any long-only portfolio is the market value of its assets less the present value of its liabilities. And the present value of liabilities should be determined by discounting future liabilities with current interest rates.

Of course in the current low interest rate environment the present value of liabilities for many pension plans is much greater than the value of the assets, making these plans insolvent. That would mean companies need to inject cash into these pension plans each year to keep them afloat. But here comes MAP-21 to the rescue. Let's allow pensions to use interest rates averaged over the past 25 years to discount the liabilities. That makes the discount rates much higher and the discounted liabilities much lower. It's not mark to market but rather mark to the past 25 years. All of a sudden companies don't have to pony up large amounts to keep these pensions afloat. Magic....

Sober Look
Kicking the pension can down the road


Gives "unfunded liabilities" new meaning.