YOU CAN CHANGE THE RULES BUT THE CHECK BETTER CLEAR THE BANK

Posted by: Howard Silverblatt on November 12, 2008

A lobbying group has sent the U.S. Congress a letter (signed by 300 companies: public, private, business groups) asking that the funding requirements for Defined Pensions under the Pension Protection Act of 2006 be suspend for one year. The letter states that current market conditions have deteriorated their assets and that if plan sponsors divert cash to the pensions it “will increase unemployment and slow our economic recovery”.

There have been discussions of this for several weeks now. Congress, if it desires, can amend the rules when it comes back into session next Monday (11/17), or in January (under new management), making the rules retroactive, prior to the required payments. As noted below (Oct 22 posting), pensions have the potential to set a new under funding record this year (2002 was -$219B). While assets are the center, the key item is the liabilities. Due to the current yield curve the rate used to determine liabilities is high, the discounted liabilities are therefore smaller, making pension funding appear at a higher level. The joke, back in 2002, was that if rates were high enough pensions would be fully funded. While rates are no where near that high, the situation has to be looked at not just from a GAAP and ERISA basis, but from cash flow. With retirees living longer and the ranks of retirees growing due to recent layoffs and packages, time for assets to recoup from the current downturn is limited, and rates remain anything but stable. On aggregate, S&P Industrial (Old) companies have sufficient cash on the side line (record Q2 value of $648B) to cover pension costs, but that’s on aggregate. There are a host of high-priority issues before congress and the administration, this, while much lower down, is now on the table.

October 22, 2008
COMPANY PENSIONS THAT WERE OVER FUNDED ARE EXPECTED TO TAKE A HIT, A VERY BIG HIT

Last year S&P 500 companies were able to brag with $63 billion in over funding for their pension funds, a value not seen since 1995. Well, its ten months later, and at this point it looks like they are on the way to reporting the largest under funding in history.

Going into the year the companies estimated an 8% return on their pension assets for 2008, and used those numbers in their reporting, allocations, and planned contributions. They had 61% of their money in Equity, 28% in Fixed Income, 4% in Real Estate and 7% in the catch all Other category. They also had 15% in foreign markets, which significantly helped them obtain that over funding status last year. Well, while someone might be doing 8%, the reality is that any pension fund manager that is even breaking even this year is most likely demanding a bonus. The U.S. market is down over a third, and that’s good compared to the Emerging markets that are down over half this year alone – so that 61% in Equity may not be doing that well. Interest rates are down, but the key to the 28% in Fixed Income is what instruments you are invested in. At best a small profit would be nice; at worst, some of the fixed investments may make the mark to market level three look good. When you calculate it all out at the current market returns, or even assuming a nice Q4 rebound, you get a number that is worse than the $219 billion in under funding reported in 2002, and that’s after starting from the positive 2007 $63 billion position.

Since 2002 the accounting requirements have changed, and companies now have to put their funding status on the balance sheet; and since assets still equal liabilities, equity will have to be marked down. The under funding will also have to be addressed with large unplanned cash infusions, which will come at a time when liquidity is tight. Overall, I expect few companies to remain over funded and for the payments to add more pressure on companies to reduce the already dwindling number of defined pension programs out there.

Then there are retiree medical programs, but going into that might be hazardous to your health.

If you want the2007 pension report, please click on the link
http://www2.standardandpoors.com/spf/pdf/index/051908_SP500_PENSION-Report.pdf

Reader Comments

Bull

November 13, 2008 9:53 AM

Its just amazing how one-side & biased BUSINESS directed arguments can be.

True, the 2006 PPA will require significantly higher funding requirements due to the drop in stock values. So, protecting their interests, businesses are seeking the reversal of the "funding" changes. In fairness, if Congress makes this change, they should ALSO reverse the change in the interest rate basis used in the calculation of Lump Sum payouts. This change, from a 30-yr treasury rate to a 3-segment corporate bond rate is being graded-in over 5 years from 2008-2012. When the 2006 PPA was passed, the "spread" (i.e., the excess of the corporate bond rate over the 30-yr treasury rate) was approximately 1.25%. The ANTICIPATED impact of this change (for retiree in the typical 55-65 age range) was a REDUCTION in lump sum pension payout of approximately 11.25% after the change was FULLY graded in by 2012 (or roughly a 2.25% reduction in payout in EACH of the 5 years 2008-2012). Well, the current economic/credit crisis has the effect of a hugh ADDITIONAL decrease in lump sum payouts (COMPLETELY unanticipated and certainly not the intent of Congress). With the "spread" between Corporate Bonds and 30-yr treasuries now (for October 2008) at 3.75%, the lump sum REDUCTION originally anticipated to be about 11.25% will now be 3 times this amount or 33.75%! In fact for NEXT YEAR'S (2009) lump sum payouts, an informed retiree might have known about the anticipated payout reduction of about 4.5% (based on 2 years of the 5-yr grade at 2.25% per year), but now, (if based on the October spread of 3.75% as many plans use for ALL 2009 payouts) the 2009 payout will be about 13.5% lower (2/5 of the full 33.75%)!

Since this was completely unanticipated and unintended by Congress, any rollback of the FUNDING basis to reduce employer contributions should be accompanied by a rollback of the change in lump sum interest rates. Plan participants should NOT suffer this significant ADDITIONAL reduction in payout (which translates into a windfall for Plan sponsors) due to the current crisis.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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