The unfunded liabilities of the US’s 19 largest pension
plans rose to $189 billion, an increase of $12 billion from last year,
according to a new
report from Russell Investments. The shortfalls from the 19 pension funds
of the nation’s largest publicly-traded corporations in the healthcare,
aerospace, automotive, technology, oil and gas, logistics, and chemical
sectors, rose due to a fall in the discount rates used to value liabilities.
While these large corporations, which Russell calls the “$20
Billion Club,” saw an increase in liabilities, the long-term liability trend is
going lower, the report found. The 2016 total of $902 billion is below the high
point of $933 billion reached in 2014. “Unless there is a substantial fall in
interest rates this year, 2014 may well prove to be “peak pension,” the point
at which defined benefit plan liabilities reached their high,” the report said.
Yet as liabilities rose, the report found that assets continued
to grow. Asset growth would allow plan sponsors to address their collective $189
billion pension fund deficit. This would mean that with 2016 total assets less
than 5% below 2014’s level, strong investment performance in 2017 could see a
new high, the report said.
Pension funds were also negatively affected by
mark-to-market accounting which accelerated gains and losses and contributed to
higher pension costs in 2016. The fall in the discount rate and other market
factors were all realized more quickly as a result of mark-to-market
“The total loss recognized by the six corporations who use a
mark-to-market approach was $9.9 billion, approximately 4% of year-end
liability value. The loss recognized by the 13 corporations who do not mark to
market averaged less than 2% of their liability value,” the report said.
According to Bob Collie, chief research strategist, the main
reason for the decline in 2016 was a decrease of about 0.25% in the discount
rate used to value liabilities. However, this decline was offset by a slight
increase in plan sponsor contributions and a slight rise in investment returns.
force affecting the underfunding was interest rates, specifically the median
discount rate used to value liabilities.
His accounted for the actuarial loss of $38.7 billion among the pension
plans of the largest corporations.
On the asset
size, the report said investment returns “were solid,” with returns ranging
from 4.7% to 12% from the 18 corporations that reported returns on a calendar basis.
“This was more than enough” to cover the interest cost of $31.9 billion in
liability growth, the report said.
were another story. These varied widely among the 19 corporations, with about
half making discretionary contributions in 2016 and the rest failing to make
them. One reason for the differences in voluntary contributions was due to
increases in the PBGC’s variable rate contribution schedule. This change gave
pans a few more choices in how they addressed their underfunding situations. These
changes, Collie said, meant “sponsors will increasingly choose to make
discretionary contributions above the required minimum in order to reduce their
Looking ahead to 2017, Collie said “while the past few years
have shown that interest rates have been the biggest factor driving changes in
interest rates (even more than investment returns), if we enter a rising rate environment, we could see
substantial improvement in funded status. If we look, for example, at 2013’s improvement
that was mainly caused by the median discount rate used to value liabilities
rising from 4.0% to 4.89%. If rates rise in 2016, we’d expect to see a similar
effect. The other cause of year-to-year variation is, of course, investment
returns. Those are the big two.”
Collie also said contributions are important,” especially
when you look at the longer term. Currently, contributions are still fairly low
as many corporations continue to take advantage of the flexibility offered by
funding relief to defer contributions. But, we expect to see discretionary
contributions tick up as a result of PBGC premium increases, and there are
signs that’s starting to happen. Overall, the pension fund situation really
comes down to interest rates and investment returns,” Collie said.
When Should a Pension
Plan Borrow to Fund its Liabilities?
In contrast to Russell’s latest 2016 report, pension plans in 2015 started to borrow money rather
than continue with a pension deficit. In a paper
written by Russell’s Jim Gannon, changes in the way the Pension Benefit
Guaranty Corporation (PBGC) gave underfunded plans more flexibility in how they
corrected their shortfalls. This change, which was part
of the in the Bipartisan Budget Act of 2015, gave sponsors more options in
determining their contribution schedules, including a reduction in their minimum contributions to correct
underfunding. But it also meant they could face higher costs from the PBGC’s
variable funding option, which is a high costs for underfunded plans.
In a scenario modeling
“amortization of unfunded liabilities,” Gannon used key variables (such as credit
rating, interest rates, PBGC premiums) to calculate whether the “breakeven rate” makes more sense
for the corporation to either borrow or continue to fund the plan annually.
By Chuck Epstein