2009 Respite Brief for S&P 500 Pensions: Report

According to S&P 500 2009: Pensions and Other Post Employment Benefits (OPEB) by Standard & Poor’s, the underfunding status of those programs improved to a US$ 261 billion short fall from a short fall of US$ 308 billion, and the pension funding rate increased to 81.65% from 78.10%.   

The report also noted that the discount rate declined to 5.81% from 6.29%, and the expected return rate declined to 7.83% from 7.95%, compared with a year ago. 

However, laid-off workers, who otherwise might have remained with their employers, have added additional unanticipated expenditures to pensions as early retirees, and while a noted shift back to equities from the relative safety of fixed income helped in 2009, the current market pullback shows the dangers attendant with that approach. 

As Medicare and Medicaid obligations dwarf Social Security’s issues, the report cautions that OPEB underfunding remains “massive”, even as underfunding was reduced to $215 billion from $257 billion.  

In fact, according to the analysis, only 18 issues were overfunded in pensions for 2009 compared to 296 issues ten-years ago. Only four issues were overfunded in OPEB in 2009, with just one of those issues overfunded in both pensions and OPEBs. 

Industry Analysis 

The report notes that while defined benefit pension plans are more common among large corporations, they are not universal with respect to sector representation, specifically that companies in Information Technology (a relatively new sector with high employee turnover) were least likely to have those programs in place, while companies in the Utilities and Materials sectors were most likely to have those DB plans.  Additionally, S&P explained that funding levels also vary across sectors; that, over the past several years, the Telecommunication Services sector remained the sole sector with overfunding (a legacy from the AT&T breakup).   

However, the report states that the massive losses of the 2008 recession have served to strip the Telecommunications sector of its unique status, and have left it underfunded for both 2008 and 2009.  On the other hand, the Financials sector, which has arguably suffered the most during the recession, reported the least negative underfunding (8.26%), along with fewer employees, according to the report.  Ironically, the Energy sector, which the report says has performed (relatively) well with respect to market prices, earnings, and cash flow, is the most underfunded sector - with a 28.56% underfunded status (improved from 39.46% underfunded in 2008). 

“Ironically, the Telecommunications Services sector, which traditionally has been overfunded in pensions, has gone through so many reductions in their work force where early retirement was permitted that it now finds itself paying for those “humane requirements,” according to the report. 

Asset Allocations 

Pension funds have US$ 1.16 trillion in assets, with 86.1% invested in U.S. concerns and 13.9% invested abroad, percentages which S&P says have changed little over the past several years.  However, the report notes that, over the past few years, the asset allocation matrix, however, has changed significantly.  S&P notes that for 2009, pension funds reallocated their assets out of equities (63.1% in 2008 to 43.7% in 2009) and into fixed income (32.3% in 2008 and 42.9% in 2009); a shift resulting from what S&P termed “the new balance between perceived safety (fixed income) and acceptable risk (equities), inspired by the Bear market and the Financial liquidity crises”.  That said, while assets may have shifted, the overall pension fund portfolio return declined only slightly; from 8.02% to 7.95%.  

Then as the bull market of 2009 took hold, funds again shifted their allocation, this time back to equities, “chasing higher returns and accepting the higher risk associated with the shift,” according to the report authors. The year-end 2009 result is that allocations to equities increased back up to 50.40%, while fixed income allocations dropped back to 38.03%.  “Given the equity gains of 2009, the ending asset allocation value suggests that fund managers may have taken some equity profits along the way, limiting the upward rise in equity allocations, and reducing corporate contribution,” according to the report. For 2010, S&P 500 issues are estimating that they will contribute US$ 32.1 billion. “Given the change in allocations, the current market correction will have a greater impact on pensions. Based on the 7.83% estimated 2010 return, the aggregate year-to-date projections are US$ 66.2 billion short of their goal,” according to the report. 

The report acknowledged that legislation resulting in the temporary suspension of pension funding requirements in December 2008 “reduced the short-term obligations of many corporations, but did not change the requirements or schedule for current and future payments,” and also that the resulting one-year suspension of accelerated payments “did not give the market (or funds) sufficient time to recover from their massive downturn.”  More succinctly, “While the band-aid helped, it has now been removed.” 

The report notes that, to some extent, the long-term funding rate may depend more on the discount rate used than the actual returns, and that while short-term rates are expected to slightly increase, it is generally believed that once the economy is strong enough, longer-term rates will rise – and that the resulting higher discount rate will reduce the future liability and improve funding - at least on paper.  “The side-bar joke is that if rates go up high enough, full pension funding would be accomplished and success declared,” according to the report.  However, it also notes that “the reality is that you can write as many paper checks as you want, but the bank will only clear the ones for which you have enough cash”. 

“It should be noted that while plans may be deficient, companies are awash in cash, with Q1 2010 setting a new cash and equivalent record for the S&P Industrials (Old), at US$ 837 billion, the equivalent of 72 weeks of expected operating income.”  That said, in view of the demographics, the report says “it remains mathematically difficult to extrapolate an S&P 500 pension fund that will be fully funded within the next several years”.    

S&P’s optimistic estimate, based on an S&P 500 at 1310 (which is 20% above the current close) and interest rates 50 bps higher (across utilized maturities) calculates out to a pension 

improvement, but underfunding remains solidly in the red by US$ 150 billion. On the other hand, the “gloomy forecast”, based on the current market correction turning into a Bear market combined with slightly lower interest rates, increases the underfunding to a record US$ 395 billion.” 

OPEB Obligations 

The report also looked at OPEB obligations.  The report acknowledged that the state of OPEB “remains extremely poor largely due to the lack of uniform information available and lack of funding requirements. Therefore, analysis and evaluations have limited use and projections require large disclaimers”.  The researchers note that as medical and drug costs continue to escalate (with many at a double-digit rate) and combine with higher life expectancies, the estimated growth rate used in determining the present value of OPEB becomes the major factor in the evaluation. 

Within the S&P 500, 293 companies (flat from 2008 and down from 310 companies in 2007) offer OPEB, with the aggregate underfunding of US$ 214.6 billion representing a 22.2% funding rate, up from 20.3% in 2008. “While funding levels have increased, the stark contrast is to pensions which, while also underfunded, have significantly more asset coverage (81.7%),” according to the report.  Combined, pension and OPEB assets set aside for issues in the S&P 

500 amounted to US$ 1,221.3 billion, to cover US$ 1,696.6 billion in obligations, with the resulting underfunding being US$ 475.3 billion, or 28.0% of underfunding, compared to 32.7% in underfunding in 2008.  Within the S&P 500, only four issues were overfunded (the same four as 2008): JP Morgan Chase, LSI Corp, PerkinElmer, and Principal Financial. Of note is JP Morgan 

Chase, which is the only issue to also be funded for pensions, and therefore, the only issue within the S&P 500 to be fully funded for both pensions and OPEB, according to the report.   

The report noted that, given reduced benefits, reduced personal and retirement accounts, and increased retiree longevity, workers who have a choice will delay retirement, change lifestyles, and accept that retirement as they envisioned it may not exist.  However, the report also noted that, while pensions remain significantly underfunded, the record level of cash held by S&P 500 companies makes the obligation a business item, not a retiree problem. 

The report is online at http://www.standardandpoors.com/indices/index-research/en/us