Hey, Buddy, Can You Spare $40 Billion

By Staff Report

Nov. 28, 2008

U.S. companies could face a pension contribution tab of $40 billion thanks to this year’s financial crisis.

Plus, the falling markets have corporations looking at an expected combined pension deficit of well over $200 billion, their worst ever.

But for many companies the situation, while dire, isn’t desperate; they have a war chest of cash giving them the ability to pay increased contributions, and they might even be able to put off paying them for a year or more under pension funding rules.

The funded status of the U.S. defined-benefit plans of companies in the Standard & Poor’s 500 index was 86 percent. That means an aggregate underfunding of $160 billion as of mid-November, estimated Michael A. Moran, vice president-portfolio strategist at Goldman Sachs Group in New York.

In contrast, at the end of 2007, the U.S. plans of the S&P 500 companies were 108 percent funded for a surplus of $95 billion, he said.

Contributions for 2009 for these companies could approach $40 billion because of the huge swing to underfunding, although Goldman Sachs hasn’t made an official estimate yet, Moran said.

In 2007, the S&P 500 companies contributed a combined $26 billion, he said.

Alan Glickstein, senior retirement consultant and actuary at Watson Wyatt & Co. in Dallas, said, “What companies will definitely feel is the legal requirement for pension contributions” kicking in this year under the Pension Protection Act of 2006.

“That’s going to be painful for some plans, which is why many of them have asked for relief from minimum funding requirements” under the law, Glickstein said.

Prompted by a plea from a coalition of 298 corporations, labor unions and trade groups asking for funding relief, the leaders of two Senate committees—the Senate Finance and Health, Education, Labor and Pensions committees—reached an agreement November 19 on a bipartisan proposal to provide funding relief to corporations by modifying the Pension Protection Technical Correction Act of 2008.

That legislation passed by the Senate in December 2007 and the House in July of this year but has not been reconciled or enacted. The modified bill relaxed some requirements for both single- and multi-employer pension plans under the PPA. Jason Hammersla, director of communications at American Benefits Council, said the Senate and House adjourned November 20 without taking up the modified bill.

Possibly record-setting
Looking at both the U.S. and non-U.S. plans of the 348 companies in the S&P 500 with defined-benefit plans, the aggregate deficit could be higher than the $219 billion deficit in 2002, the highest on record, said Howard Silverblatt, senior index analyst with S&P in New York. (For more, read “$4 Trillion Lost Worldwide by Pensions Funds in 2008.”)

That would be a swing of almost $300 billion, wiping out the aggregate $63.3 billion in overfunding the S&P 500 companies (combining U.S. and non-U.S. plans) had at the end of 2007, Silverblatt said.

Said Adrian Hartshorn, senior consultant in the financial strategy group of Mercer, New York: “It’s been a difficult year. The funding levels will be substantially down from where they were in 2007. We’re expecting a fairly substantial number [of corporate pension plans] to be underfunded.”

The hit to funding levels is entirely a result of the collapse in returns on the asset side, those interviewed said. Because of rising interest rates—especially the wide spread between corporate and Treasury bonds—pension liabilities have fallen, offsetting somewhat the drop in pension assets.

“Pension funds typically have between 60 percent and 70 percent of assets invested in equities,” Hartshorn said, extrapolating an estimate of underfunding. “Equities are down 40 percent year to date. That [decline] translates to a 30 percent loss on the asset side.”

The sharp losses will lead to a reconsideration of pension investment strategy, he said.

“Companies need to understand risk,” he said. “If the risk they are assuming is too high for a company’s business, they need to mitigate it. They need to re-evaluate policy goals of the risk they are taking to achieve full funding status,” he said.

If the high volatility of the market is too much for a company to withstand, executives need to look at some sort of liability-driven strategy, where assets are invested generally in fixed income in a way to match the interest rate sensitivity of pension liabilities.

October was the worse month for pension assets in the eight-year history of the Milliman Inc. index of the largest 100 corporate pension plans.

In October, the net asset return for those pension plans was -21 percent, in contrast to the annual expected return of 8.3 percent, according to John Ehrhardt, principal and consulting actuary at Milliman in New York.

Ehrhardt estimated those plans lost more than $120 billion in October. Offset by gains in pension liabilities, the funded status dropped $58 billion in October.

As a result, the combined funded status of those companies as of October 31 fell to 92.7 percent from 104.9 percent as of the end of 2007, Ehrhardt estimated. The total value of pension assets of the Milliman 100 was $986 billion as of the same date, down from $1.106 trillion at the beginning of the month. At the same time, pension liabilities fell by $62 billion to $1.064 trillion.

Ehrhardt attributed the decrease in pension liabilities primarily to the rise in the discount rate to 8.45 percent in October from 7.63 percent in September.

Besides causing big expected increases in cash outlays for pension contributions, the rise in pension underfunding will hurt corporate financial statements and shareholders.

“There will be a lot of [pension] asset losses,” Moran said. “It’s going to be immediate and it’s going to look ugly,” he said of the impact on the balance sheets, which will appear in corporate 10-K statements after the beginning of the year.

Ehrhardt projects a reduction in corporate earnings for 2009 of $40 billion because of the pension plan losses. (For more, read “Retirement Out of Reach.”)

Filed by Barry B. Burr of Pensions & Investments, a sister publication of Workforce Management. To comment, e-mail

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