Bodie points out that the rules reflect the mistaken idea, “actually believed by actuaries, that equities are basically not risky if you hold them for the long term.” A good start to sorting out this mess would be to adopt accounting rules that make sense, for example by insisting on the use of true current market valuations. Britain has taken a big step in this direction with a rule called FRS 17, and the result has been a move of pension fund assets out of equities into bonds, which offer a better match to the relatively fixed obligations of defined-benefit pensions. However, hoping perhaps for a rise in share prices and/or interest rates, most firms have been reluctant to go as far as Boots, which in 2001 switched its fund entirely to bonds (a move that was subsequently watered down). That may prove to be a mistake, says Bodie.
America’s Financial Accounting Standards Board (FASB) has said it intends to improve pension fund accounting, though it remains to be seen if it can do a better job of resisting hostile lobbying from companies than it did when it proposed tougher accounting for employee share options. The Securities and Exchange Commission is also taking an interest in this area.
Further, the Bush administration has proposed raising the premiums charged to firms by the PBGC, which is supposed to be self-financing. Ideally, premiums should reflect the riskiness of individual pension funds. However, this idea is facing considerable opposition, not least from unions, which argue that charging higher premiums to firms already unable fully to fund their pensions will push more of them over the edge into bankruptcy.
Tackling the OPEB burden may be even harder. A growing number of firms are trying to find ways to reduce healthcare inflation by getting consumers to bear more of the cost, giving hospitals a financial incentive to be efficient and by promoting healthier lifestyles. So far, there is not much evidence of success. More company bosses are calling for a greater role for government in financing retiree health care, and are hopeful that the new Medicare prescription benefit, which should reduce their legacy costs a bit, is the start of a trend. Whether that view is shared in Washington, D.C., remains to be seen.
Failing that, companies may simply have to be less generous. Sears, for instance, recently announced that it would no longer subsidize health insurance for retirees (though existing retirees have their subsidies grandfathered). There is much debate about whether OPEB promises are legally binding in the way that pensions are. In the past 15 years, many firms have couched their promises in legalese that appears to give them wiggle room.
Yet cutting OPEBs may be far harder than many firms believe, particularly where they are the result of a union negotiation, says Christine Lutgens, a lawyer at Kramer Levin. Although courts across America differ in their view of how binding union OPEB promises are, particularly in a bankruptcy, those serving Detroit (unlike in New York and Texas) have tended to favor the rights of union employees and retirees over employers, she says.