Friday, August 4, 2017

America's Corporate Pension Disaster?

Brandon Kochkodin and Laurie Meisler of Bloomberg report, S&P 500’s Biggest Pension Plans Face $382 Billion Funding Gap:
People who rely on their company pension plans to fund their retirement may be in for a shock: Of the 200 biggest defined-benefit plans in the S&P 500 based on assets, 186 aren’t fully funded. Simply put, they don’t have enough money to fund current and future retirees. The situation worsened for more than half of these funds from fiscal 2015 to 2016. A big part of the reason is the poor returns they got from their assets in the superlow interest-rate environment that followed the financial crisis. It’s left a hole of $382 billion for the top 200 plans.

Of course, the percentage of workers covered by traditional defined benefit plans—those that pay a lifetime annuity, often based on years of service and salary—has been declining for decades as companies shift to defined contribution plans such as 401(k)s. But each time a pension plan is terminated, canceled or altered, thousands of workers are affected.

Last month, the 70,000 participants in the United Parcel Service Inc. pension plan learned they won’t earn increased benefits if they work after 2022. Late last year DuPont Co. announced it would stop making payments into its pension plan for 13,000 active employees, and Yum! Brands Inc. offered some former employees a lump-sum buyout to offload some of its pension liabilities. General Electric Co. has a major problem. The company ended its defined benefit plan for new hires in 2012, but its primary plan, covering about 467,000 people, is one of the largest in the U.S. And at $31 billion, GE’s pension shortfall is the biggest in the S&P 500.
Below, you will find two charts related to this article (click on images):



I've already covered how GE botched its pension math and now I'd like to widen the lens to look at the state of US corporate pension plans, and it's not good.

Sonali Basak, Katherine Chiglinsky, and Brandon Kochkodin of Bloomberg report, Corporate Employers Flee Pensions With Gap Topping $375 Billion:
The vast majority of S&P 500 companies don’t have enough money set aside to meet all their obligations to current and future retirees. There’s a total gap of at least $375 billion for the 200 largest plans. This is how they got here.

1975 to 1999

Assets in U.S. pension plans go from $186 billion to more than $2 trillion. A booming stock market helps the funds grow, since many are largely invested in equities (click on image).


2000 to 2005

The dot-com bubble bursts and markets tumble, pushing many big corporate pension plans into the red after having a surplus. Bankruptcies of companies including United Airlines Inc. put a burden on the Pension Benefit Guaranty Corp., the government agency that backstops plans.
2006

President George W. Bush signs the Pension Protection Act, which promises to make pensions safer—and less likely to end up in the hands of the PBGC.

2008

The new law puts stricter funding requirements on companies with plans but comes just in time for the financial crisis and a brutal recession. Pension plans lose about 15 percent of their value in a single year.

Post-Crisis

The market climbs back, though not enough to make pensions whole. That’s partly due to low interest rates: The accounting value of a pension liability rises when rates fall, because it becomes more difficult to earn the money needed to meet future costs. Companies are also spending money on stock buybacks and acquisitions to boost shareholder returns, sometimes at the expense of pension obligations. General Electric Co. has spent $45 billion on buybacks in recent years—and has a pension shortfall of $31 billion. The company says it will put $3 billion into its plan in 2017 and 2018 (click on images).



Now

Companies are eager to get out of the pension business. Most prefer 401(k) plans, where the employee alone bears the risk of falling short at retirement. More are also offloading their pension plans, paying insurance companies to take them on instead. Only about two dozen companies in the S&P 500 have overfunded pensions. Nine of them are banks.
A few observations from me:
  • Pensions are all about matching assets and liabilities and since the duration of assets is much lower than the duration of liabilities, the decline in rates has disproportionately hurt private and public pensions because liabilities have grown a lot faster than assets.
  • Unlike public pensions which use an assumed rate-of-return of 7% or 8% to discount future liabilities, corporate pensions use a market rate based on corporate bond yields (see below). This effectively means that the way American corporations determine their future liabilities is a lot stricter and more realistic than the way US public pensions determine their liabilities.
  • Companies hate pensions. Instead of using money from corporate bonds to top up their pensions, they prefer using these proceeds to buy back shares, rewarding their investors and propping up executive compensation of their senior managers.
  • The pension crisis is deflationary and will only ensure low rates for a lot longer. Shifting out of defined-benefit plans into defined-contribution plans will only exacerbate pension poverty.
Now, let me thank Mathieu St-Jean, Absolute Return Manager at CN Investment Division, for bringing the top article to my attention. I commented on his LinkedIn post but lost it and there was a very nice actuary who corrected me, stating the discount rate corporate pensions use is A or AA, not AAA bond yields.

The point is that corporate pensions use a market rate, not some assumed rate-of-return based on rosy investment assumptions. Some argue this is way too stringent while others argue it is far more realistic and if US public pensions used this methodology, their pension deficits would be far worse than they already are.

Lastly, following my comment on HOOPP's warning of a crisis, Bernard Morency, the former Executive VP of Depositors at la Caisse, sent me this:
On the issue below concerning corporations getting out of the pension business and letting Federal and States (provinces) handle it. As you know, I have been an advocate of a better C/QPP. However, don’t you think that, especially in the US, the States have proven that they are more unfunded and, perhaps, have botched pension math even more than corporations? So we would need to be especially careful if we were to ask them to do more.
Excellent point and let me clarify something, my recommendation is to have large, well-governed public pensions handle all the pension needs of a society. If they don't get the governance right, then state pensions shouldn't be managing corporate pensions. Period, end of discussion.

But clearly America has a public and private pension problem and it is only getting worse, leaving millions exposed to reduced pensions and pension poverty.

And make no mistake, America's pension crisis is a big part of the $400 trillion pension time bomb threatening the global economy and it is deflationary and bond friendly.

Below, a YouTube clip on America's pension crisis which covers an important topic. Even though I don't agree with everything, watch it, he covers the main points.

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