US reforms set to help pension funds Looming legislation in Washington awaiting the signature of President Barack Obama is set to provide welcome relief to US pension plans. A pronounced slide in interest rates in recent years has placed defined benefit pensions at many companies such as US Steel, Goodyear, Boeing and Lockheed Martin under pressure, driving up their liabilities and resulting in an expanding "pension funding gap." IN Pensions Industry Under the new legislation, instead of discounting long-term liabilities using a rate based on the average of the past two years, pension plans will be able to use a rate based on the average of the past 25 years. This is expected to increase the discount rate used to determine liabilities by more than two percentage points. The change only applies to the rate pension plans use to discount liabilities for the purpose of setting company contributions. It will not affect how liabilities are calculated in order to report deficits (or surpluses) on company balance sheets. But it will significantly lower many US companies" pension plan contributions, boosting corporate profits and thereby raising tax revenue for the Federal government. Similar developments are taking place in Europe, where pension plans have also seen deficits widen as a result of record low interest rates. Denmark and Sweden last month moved to ease rules for calculating pension liabilities, and UK pensions minister Steve Webb, speaking at a recent conference, expressed interest in following their example. However, David Hartshorn, partner in Mercer's Financial Strategy Group, says there is no indication to suggest the UK would move to allow pension funds to smooth the discount rate, unlike developments in the US. He said the Pensions Regulator acknowledged in a recent announcement the low level of interest rates compared with 12-18 months ago but expected pension fund trustees "to adopt a point in time approach and not to smooth." Joanne Segars, chief executive of the National Association of Pension Funds, has suggested the Regulator will have to reconsider in the light of the expected third round of quantitative easing by the Bank of England. This would have a knock-on effect on pension schemes, says Ms Segars "and we need some creative ideas [to help pension schemes]." Looking to smooth the discount rate used in the UK triennial scheme valuations that determine funding levels could be one of the options considered, she adds. In the US, meanwhile, it remains to be seen whether pension plans are set to increase their weightings to equities as the new legislation comes into force. Since 2007 US corporations with large pension obligations have been big buyers of bonds at the expense of equities helping send US Treasury yields to their lowest levels since 1946. US Treasury debt held by defined benefit private pension plans had risen fourfold to $284bn by the end of March 2012, against $71.8bn in 2006 according to Federal Reserve data. Equities held by pension plans have fallen to $1.25tn from $1.8tn during this period. This has reduced the weighting of equities in relation to overall assets in pension plans from 72 per cent in 2006 to as low as 52 per cent in 2011. And earlier this year, Ford said it was moving towards holding 80 per cent of its pension fund assets in bonds, up from a prior weighting of 45 per cent. Companies with large pension funds and little cash on their balance sheets may want to minimise their exposure to interest rate volatility by selling long bonds or holding off on extending their long bond allocations, says Gordon Fletcher, a principal in the financial strategy group at Mercer, an advisory firm. "Some companies may be looking at that and thinking how they can make their assets less sensitive to interest rates," Mr Fletcher said. Long bonds are very sensitive to interest rate movements. Some argue that pension plans will stay with bonds as they still need to match long-term liabilities. Karin Franceries, pension strategist at JPMorgan Asset Management, says that the bill will cause funds that were hesitant about de-risking their plans to delay further on implementation. Other actuaries have been cautioning clients against taking a short-term position, arguing that the legislation is only giving them a short-term deferral in cash contributions.