U.S. Pension Woes Worsening?

James Nash of Bloomberg reports, U.S. Pension Assets Gained 16.4% in ’11:

U.S. public pension funds rose 16 percent in the year ended June 30, narrowing the gap between their assets and liabilities to the lowest level since 2008, according to a report by Wilshire Associates Inc.

The 126 state pension plans had an average of 77 percent of the assets needed to pay their long-term obligations to retirees, up from 69 percent a year earlier, according to the study released today.

Rising retiree costs are straining the budgets of states and cities across the U.S. coping with the lingering effects of the longest recession since the 1930s. The gap is the narrowest since the economic contraction was amplified by the collapse of Lehman Brothers Holdings Inc. in September 2008.

“It’s been a pretty unique and pretty wild ride for the the last decade,” Steven J. Foresti, a managing director at Wilshire, said by telephone from Santa Monica, California. “The funding levels are still at a pretty low point compared to historical levels.”

U.S. pension funds had a median of 75 percent of the assets needed to pay long-term obligations in 2010, according to an annual study by Bloomberg Rankings. That number was down from 76 percent a year earlier, the study found.

Even with the growth in assets last year, 90 percent of U.S. pensions don’t have enough to cover all of their expected liabilities, the Wilshire study shows. A year earlier, the figure was 98 percent.

Annual Return

The 126 pension funds rely on a median 8 percent annual return on invested assets in their projections, while Wilshire forecast 6.4 percent. The numbers aren’t fully comparable because Wilshire’s projections are for 10 years while most pension funds have a window of 20 to 30 years, the report noted.

Over the past decade, the funds have pulled back from U.S. stocks and bonds in favor of an investment strategy that relies more on real estate, non-U.S. stocks and private equity, the report said. That has slightly reduced the funds’ exposure to risk, according to Wilshire.

“What you’re seeing across the systems is a desire to maintain growth embedded in the portfolios but to do it in a more balanced way,” Foresti said.

Reuters also reported on this Wishire report:

A strong global stock market boosted U.S. state pension fund assets by 16.4 percent in fiscal 2011, narrowing funding gaps that burst open after the financial crisis in 2008 , Wilshire Consulting said in a report made public on Monday.

Offsetting a 3.3 percent increase in liabilities for the same period, the asset boost improved the plans' funding ratios to 77 percent in fiscal 2011, up from 66 percent in fiscal 2010, the report found.

"There's been a notable improvement from the 2010 statistics, but these plans in aggregate have a long way to go to get back to 100 percent funding," said Steve Foresti, a managing director at Wilshire.

The survey examined 126 state retirement systems and the market valuations of their assets. Most of the funds had submitted actuarial data on or after June 30.

Despite the improvement, about 90 percent of pension plans are still underfunded, the report found.

State unfunded pension liabilities have increasingly been cited as credit concerns by Wall Street rating agencies. And some states have been attempting to rein in pension costs by reducing benefits, raising the retirement age and increasing employee contributions.

Indeed, Bloomberg reports, NYC Pension Costs Rose Fivefold Since 2002, Reform Group Says:

New York City pension costs have risen more than fivefold to $8 billion since 2002 and changes to the system are needed to keep budgets in check, said a bipartisan coalition for pension reform.

The increase in pension costs has squeezed funding for other programs, New York Leaders for Pension Reform said today in an e-mailed statement. The coalition supports a plan by New York Governor Andrew Cuomo to lower pension costs in New York City and state through changes to plans for future employees.

Pensions will account for an estimated 28 percent of all New York City workforce expenses in fiscal year 2013, said the group, composed of mayors from Albany, New York City, Rochester and other cities, as well as county executives. That’s up from 9 percent in 2002. The group backs a plan for future New York state and New York City employees that would “reasonably” raise retirement age and exclude overtime from formulas that use salary to determine pension payments, it said in the statement.

“The data released today details the extremely, extremely generous benefits of the pensions the City provides,” New York City Mayor Michael R. Bloomberg said in the statement. “We will continue to provide those generous packages to all current employees, but the stark reality is we simply cannot afford it for new employees. The reforms we support would save local governments billions, while still providing outstanding benefit packages to our future employees.”

Bloomberg is the founder and majority owner of Bloomberg News parent Bloomberg LP.

No matter what happens with pension assets, it is fair to conclude that states need to implement pension reforms. Pension expenses cannot continue to grow fivefold in a low return environment, it's a time bomb waiting to blow up.

And the same concerns are being voiced in the private sector. Kristina Peterson of the WSJ reports, Companies' Pension Plea:

Business groups are urging Congress to let employers put less money into their pension funds, saying that exceptionally low interest rates are forcing them to set aside too much cash.

A provision attached to the Senate highway bill would change the formula many large companies, including General Electric Co., Boeing Co. and Lockheed Martin Corp., must use to calculate how much to add to their pension funds, potentially shrinking their combined contributions by billions of dollars a year.

Though its chances of becoming law aren't clear, the measure holds appeal in Congress because it would increase the government's near-term revenues, offsetting some of the costs of the highway bill. Setting aside less for pensions would leave companies with smaller tax deductions, requiring them to pay about $7.1 billion more in taxes over 10 years than under current law, according to Congress's Joint Committee on Taxation.

The proposed change would apply to private-sector defined-benefit pension plans, which promise a specified amount of retirement pay. Though millions of Americans are covered by such plans, their prevalence has declined in past decades as companies have shifted to 401(k)s and other retirement plans that don't guarantee payouts.

Labor unions are open to changing the contribution formula, but say that Congress shouldn't allow companies to underfund their pension plans, as has happened already in some cases.

Companies with defined-benefit plans are required to use a "discount rate," based on a specific mix of corporate bond yields over the past two years, to help determine how much to contribute to their plans each year to meet their obligations. The rate varies by company.

Since the company uses the rate to help estimate the returns it can expect on its pension assets over time, the lower the rate, the more the company must contribute to its plans. GE said in its annual report that its 2011 pension expenses rose by about $7.4 billion because its discount rate dropped to 4.2% at the end of 2011 from 5.3% at the end of 2010.

GE didn't comment beyond the annual report.

Business groups argue that the two-year window used in the current discount-rate formula is too narrow, leaving companies vulnerable to short-term swings in interest rates.

The provision in the highway bill would extend the window, keeping the discount rate within 15% of an average of corporate bond rates over the preceding 10 years. A coalition including the U.S. Chamber of Commerce, National Association of Manufacturers, American Benefits Council and the ERISA Industry Committee is pushing to calculate the discount rate over a longer time period, keeping it within 10% of a 25-year average.

The business groups argue that with U.S. interest rates near historic lows, companies are diverting money into pension funds that could be otherwise used to hire new workers or make other investments.

Companies are "not opening a plant or not launching a new product because they're sitting on the cash because it's going to look like they'll owe it to their pension plan," said Lynn Dudley, senior vice president for policy of the American Benefits Council, a trade group for employers that sponsor retirement programs and other benefits.

Congress eased the rules on pension-funding requirements at least six times between 2002 and 2010, according to the Pension Benefit Guaranty Corp., the federal agency that insures the private sector's defined-benefit plans. The danger is that such assistance can have unintended results.

The PBGC estimates that Congress allowed AMR Corp., the parent company of American Airlines, to reduce the required contributions to its pension funds by $2.1 billion since 2006. That has contributed to a shortfall in the airline's pension funds, according to the agency, which says it insures the retirement income of about 44 million workers in roughly 27,500 pension plans.

American officials have said the reduced contributions were critical in helping the company successfully navigate extremely difficult conditions in the airline industry.

AMR filed for bankruptcy protection in late November. Company officials have said its pensions are too costly and may need to be cut.

The AFL-CIO, the nation's biggest labor federation, said it could support changing the pension fund formula if it is paired with protection for the pension plans' participants. "While employers do have a valid concern for realistic funding assumptions and less volatility, what we don't want to see is a repeat of what we're likely to see in American Airlines," said legislative representative Lauren Rothfarb.

Senate Republicans first floated the pension-formula measure, but haven't firmly backed it yet, a Senate aide said. Some Senate Democrats, meanwhile, say they approve of the general idea.

"It makes sense to try to get a more consistent contribution, rather than having the contribution be arbitrarily high, because of the unusually low interest-rate assumptions" said Sen. Ben Cardin, a Maryland Democrat. The White House hasn't taken a position on the pension measure.

The measure's prospects are murkier in the House, which hasn't agreed on its version of the highway package.

The minimum amount a company must put into its pension plan each year is ultimately determined in part by the plan's overall level of funding, so a jump in pension expenses one year doesn't necessarily mean the company must immediately contribute the entire sum.

Boeing's discount rate, for example, fell to 4.4% at the end of 2011 from 5.3% at the end of 2010, according to its annual report.

The plane maker estimated in January that under the current formula its pension expenses would be $2.6 billion in 2012, or $2.21 a share. It said 83 cents of that amount stemmed from the lower rate. However, because the company's pension funds are considered healthy enough under the law, it has said it expects to contribute only about $1.5 billion to them this year.

Below, Bloomberg's Dominic Chu reports on the possible hundreds of billions of dollars the 100 largest U.S. pension plans may have to pay in the next few years. He speaks on Bloomberg Television's "In The Loop."