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Don Blackwell is chief financial officer at ILM Group, an Indianapolis insurer that recently froze its pension plan.

Low interest rates kill pensions

– It was no small matter for the ILM Group’s executives when they froze the pension plan that has provided retirement security for the firm’s employees since 1947.

The financial pressure of maintaining the plan had been mounting on the small insurer for years. But until March, ILM had not given in, even as tens of thousands of other employers did. It held on when the 9/11 terrorist attacks rocked the economy, flat-lining the stocks that fund the pension payments. It also kept the plan intact when the recession shrank its holdings by 29 percent.

What finally did the plan in? Rock-bottom interest rates – the very rates that helped fuel a stock market rally and brought ILM double-digit returns on its pension-fund investments in each of the past three years.

But because of an accounting twist, the near-zero rates also caused ILM’s projected pension obligations – like those of every other private company that still provides a traditional pension – to spike, overwhelming the stock-market gains.

To calculate pension obligations, companies have to factor in the future value of money. Accounting rules peg that value to interest rates on corporate bonds. If bonds have a high interest rate, you can assume a high value for future dollars. But if rates are low, the dollar is low, and it takes more of them to meet future obligations.

So when interest rates go down, the projected obligations go up, requiring the firms to set aside more cash today to pay retirees in the future. For ILM, that meant funneling more than $2 million – roughly 22 percent of its payroll – into its pension fund over the past two years.

“I think a pension is a tremendous benefit,” said Don Blackwell, ILM’s chief financial officer and treasurer. “This is a very valuable benefit to our employees. We did not want to take it away.”

But with the pension plan causing the firm to report a $8 million liability at the end of last year and with no end in sight for low interest rates, “we waved the white flag,” Blackwell said.

“It was a waiting game and we blinked. We had no idea that interest rates would remain this low.”

The experience of ILM speaks to a new challenge confronting the old models of retirement security in a turbulent and fast-changing economy. For generations, the unprecedented gains in living standards enjoyed by the nation’s retirees were boosted by employers who offered their longtime workers a fixed benefit for life once they retired.

But that benefit is increasingly rare. Many private firms stopped offering traditional pensions and switched to 401(k)-type accounts, in large part because government rules aimed at ensuring the financial viability of the traditional plans made it more expensive for employers to provide them.

The financial risk posed by pension plans only increased when a long era of ever-steady stock-market gains ended in 2000, giving way to more volatile returns.

Now, meager interest rates are squeezing the fast-dwindling number of traditional pensions still offered by private employers, even as policymakers are searching for ways to bolster retirement savings.

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