Pension Gap– Silent Crisis in Public-Private Pension Funding– Dodging the Disaster: Reform Critically Needed or Overstated…

Pension funds of the largest companies in the S&P 500 collectively reported that their pension plans had obligations of $1.68 trillion and assets of just $1.32 trillion; the difference of $355 billion was the largest ever…

Pension plans are a type of retirement plan, usually tax exempt, wherein an employer makes contributions toward a pool of funds set aside for an employee’s future benefit. The pool of funds is then invested on their employee’s behalf, allowing the employee to receive benefits upon retirement or no longer active in the workforce.

Very few topics generate as much interest among both policy makers and general public as discussions on financial viability of pension plan funding and retirement infrastructure. It’s a silent economic crisis lurking and growing on the balance sheets of the 89,000 state and local governments in the U.S. For decades, states, municipalities and towns have been under-funding their pension liabilities, resulting in a gap between the promises made to future retirees and the funds put aside to meet those promises, which some analysts estimate could total about $4 trillion: That’s 27% of GDP.

Closing that large gap could have a severe impact on the U.S. economy… In June 2012, the Government Accounting Standards Board (GASB) approved new standards for public employee pension accounting: Rules that seek to increase transparency and bring public-sector accounting standards more in line with those used in private sector. The regulations don’t impact the amount that should be set aside for pension funds, but they alter the way pension obligations are recognized-disclosed.

According to Matthew Tuininga; pension reform is necessary but it’s more than just cutting benefits and ensuring that politicians and union leaders stop collusive scams; it’s about enabling pension funds to invest in safer investments and stop paying huge fees to hedge fund managers and investment banks… Pension funds should not be aggressively invested and retirement funds should be conservatively managed, which means that enough has to be paid into those funds so that with moderate investment results– retirees can be sure that their promised benefits will in fact be paid...

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In the article Private Pension Plans May Be Under-Funded by Floyd Norris writes: The pension funds of the largest companies in the S&P 500 collectively reported that their pension plans had obligations of $1.68 trillion and assets of just $1.32 trillion. According to S&P; the difference of $355 billion was the largest ever. Of the 500 companies, 338 have defined-benefit pension plans, and only 18 are fully funded. Seven companies reported that their plans were under-funded by more than $10 billion…

The main cause of the under-funding at many companies seems to reflect the fact that investment markets have not performed well for a sustained period, rather than a failure to make contributions to the plans. Over the last 15 years, the S&P 500 rose at an annual rate of less than 5% even with dividends reinvested… Virtually all pension funds had assumed returns would be better, leaving them under-funded when their investments failed to perform as expected.

Seven years ago, S&P said, stocks made up 65% of pension-fund assets and bonds made up 29%, with the remaining assets in real estate and other investments, like private equity funds; by last year, stocks were down to 48% and bonds up to 41%. The stock market’s erratic performance has convinced some companies that they no longer want to take the risk of guaranteeing pension payments. Also, many have closed their pension plans to newer employees and stopped accruing benefits for workers already in them. Instead, they have pushed employees into defined-contribution plans in which the worker, not the employer, bears the risk of poor investment performance.

Determining whether pension funds have adequate funding is to some extent, a work of art; for example, companies will estimate their future obligation and then discount that number based on how long it will be until the funds must be paid– plus estimate the interest rate at which the pension investments might grow. The discount rate used can have a significant effect. For example, if a company estimated it would owe $1 million in 10 years and used an 8% discount rate, the current obligation would be $434,000. If it chose a 3% rate instead, the current obligation would be $737,000…

Congress voted this year to allow funds to discount their obligations using a 15-year average of bond yields, meaning they can use a higher rate and so report lower obligations. Thus, next year, pension funds will appear to be better funded, even if they are not. Some companies announced that they would slash their pension contributions as a result of the new law…

In the article Pension Funding Status Improves First Half of 2013 by ValueWalkStaff writes: According to a report from Martin Bernstein of Citigroup; in the first half of 2013 the value of pension liabilities has declined while pension assets have mostly increased in value– meaning that pension funding has mostly improved; although pensions still have a lot of problems…

In order to estimate changes in pension funded status, in aggregate and individually for specific plans, we looked at published asset allocations and liabilities of the largest corporate defined-benefit pension plans. Our database includes almost 500 plans accounting for over $1,750 billion in asset value, as of beginning of the year.

We sourced pension data from published corporate 10-Ks in which plan sponsors disclose the value and gross allocation of pension assets, as well as the value of plan liabilities (PBO). Our analysis shows that pension funding first half-year 2013 is as follows:

  • Estimated that the funded status for U.S. corporate defined-benefit pension plans improved from 77% to 88% over the first six months of the year.
  • Funding gap fell by more than half, from -$540 billion to -$258 billion.
  • Most of the improvement in funded status resulted from declining liability values, as liability returns were approximately -8.4%, outstripping returns on most assets.
  • Percentage of pension funding of assets in fully funded plans has likely increased from 5% to 16%, and approximately 40% of pension assets are now held in plans that are at least 90% funded.

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In the article Solving the Public Pension Plan Funding Crisis by Hazel Bradford writes: Severely under-funded public defined-benefit plans will have to try a bit of many things to shrink liabilities– from benefit cuts to contribution hikes to accelerated payments– as well as, paying more attention to costs overall. According to Pensions & Investments‘ analysis of funds’ annual report data; the average funding ratio of the 100 largest public pension plans dipped slightly in fiscal year 2011 to 73.64% with unfunded liabilities increasing 4.1% from the previous year. 

One positive note, however, comes from Wilshire Associates’ annual measurement of 102 systems’ 2011 actuarial data that showed pension assets growing faster at 16.4% than liabilities which grew at 3.3%. Wilshire attributed the latest asset growth to strong global equity performance, along with more moves into other non-traditional assets.

According to Steven J. Foresti; there has definitely been, over time, a move into a larger number of asset classes and more diversification into global… it would take some really attractive returns short-term to invest your way out and one of those routes requires taking more risks. But he and other public plan experts caution that investing is not the solution to plan under-funding especially for the many plans that are still writing down investment losses that occurred in the recession. According Meredith Williams; there are pretty exotic models using various scenarios as public plans are starting to think about risk management…

In the article Pension Plans’ Funded Status Declines Worldwide by Stephen Miller writes: The funded status of defined-benefit pension plans in U.S., Canada, and major European economies broadly declined in the first nine months of 2012 (January through the end of September), while improvements were seen in UK, according to data released by Mercer, HR consultancy. Funded status is defined as the percentage of assets vs. liabilities in the plan; and the factors driving down funded status are primarily declining discount rates combined with lackluster asset performance. Discount rates are based on the yields on high-quality corporate bonds denominated in the currency of the liabilities. Multinational companies are exposed to movement in discount rates (due to changes in corporate bond yields) across multiple markets…

According to David Newman; multinationals will likely be faced with significant increases in expense due to changes in discount rates not only in the U.S., but overseas… the projected impact of the decline in funded status in these plans will have a significant impact on 2013 earnings… multinational organizations need to be mindful of the regulatory nuances in each market, and the fact that markets are not perfectly correlated, so monitoring needs to take place at a local level. For multinationals operating defined-benefit pensions across multiple geographies, it’s common for funding levels to move in different directions in some markets over the same month.

According to Frank Oldham; it’s crucial, therefore, that multinationals monitor their cross-country exposure and react quickly to capitalize on local opportunities… While the situation for each multinational depends on how their pension risk is distributed across markets and across asset classes, strategies to control the impact of market fluctuations on pension earnings are essentially same across all markets. These include liability-driven investing and risk transfer strategies, including lump-sum cash-outs and annuitization, which transfers pension risk to private insurers…

The pensions’ crisis is the predicted difficulty in paying for corporate, state, and federal pensions due to a difference between pension obligations and the resources set aside to fund them. Shifting demographics are causing a lower ratio of workers per retiree; contributing factors include retirees living longer (increasing the relative number of retirees) and lower birth rates (decreasing the relative number of workers…).

There is significant debate regarding the magnitude and importance of the problem, as well as the solutions. Proposed pensions reform ideas are in three primary categories: a) Addressing the worker-retiree ratio via raising the retirement age, employment policy and immigration policy; b) Reducing obligations via shifting from defined-benefit to defined-contribution pension types and reducing future payment amounts (by, for example, adjusting the formula that determines the level of benefits); and c) Increasing resources to fund pensions via increasing contribution rates and raising taxes…

Others argue that the pension crisis is overstated, and for many regions there is no crisis because the total dependency ratio– composed of aged and youth– is simply returning to long-term norms but with more aged and fewer youth. However, looking only at aged dependency ratio is only one half of the coin– the dependency ratio is not increasing significantly but rather its composition is changing… Another area of contention relates to the expected investment return rate: If this rate (i.e., percentage) is increased than relatively lower contributions are demanded of those paying into the system…

Critics have argued that investment return percentage rate assumptions are artificially inflated to reduce the required contribution amounts by individuals and governments paying into the pension system… So the debate goes on– there are some fundamental-debatable differences between economists, policy-makers and pension practitioners– but effective pension reform is essential…