Analysis: Rate pressures on pensions wipe out billions in profits
By Ben Berkowitz | February 1, 2013 11:14 AM EST
Pension charges wiped out more than $20 billion in fourth-quarter earnings at major American companies, as persistently low interest rates leave some of those with the largest retiree burdens no choice but to assume they need more money now to cover liabilities later.
Actuaries warn there is little chance for improvement on the horizon for defined benefit pension programs, as rates linger at historically low levels and the Federal Reserve shows no inclination to raise them. The only hope, they say, is for rates to turn around - though when, no one really knows.
Just between AT&T Inc
It is possible there will be even more before the reporting season ends. Employment lawyers say about 37 percent of people with retirement benefits still have a defined benefit plan or a mix of defined benefits and a 401(k), with little distinction across sectors.
The problem is an interest rate called the discount rate, a number that companies offering plans use to calculate the present value of their future obligations to retirees - how much they need today, in other words, to pay pensioners tomorrow.
Many large plan sponsors have chosen some version of mark-to-market accounting for their pension plans, which means they need to adjust their discount rate periodically (usually yearly) to market conditions.
When market forces dictate that they assume a lower discount rate, it can create a huge actuarial loss.
"The promises these companies have to their employees hasn't fundamentally changed at all," said Kevin Wagner, a senior consulting actuary at Towers Watson. "This is really driven by two things: one is that interest rates have just dropped, that's all, and secondly, different companies have made different decisions on how they want to account for pension plans."
Wagner and others said that choice comes down largely to how a company wants to handle its pension risk - take the hits (or someday, the rewards) immediately or stretch them out over time?
In AT&T's case, for example, lowering its discount rate by 100 basis points led to a $12 billion loss, offset only in part by rising asset values. In UPS's case, year-end discount rates fell a full 120 basis points.
"Is it something that with just a moderate increase in the economy and interest rates would reverse and actually begin to be a positive on paper? Yes. So we take it seriously but also realize that it is an accounting definition and one that could swing either way," UPS Chief Financial Officer Kurt Kuehn said in a telephone interview.
AT&T and Verizon are two of the many companies that have adopted mark-to-market pension accounting, which experts have said can be beneficial because it removes the drag of pension losses from future results. Someday, when rates rise, it could also create one-time, pension-driven increases in earnings.
In the meantime, though, it is not helping much. The well-regarded pension consultancy Milliman Inc estimated earlier this month that the country's 100 largest corporate defined benefit pension plans had a deficit of $412 billion at the end of 2012, up 22 percent from a year earlier.
In many cases, strong performance of assets was not enough to offset rising liabilities.
As the firm noted, pension fund returns have exceeded expectations in three of the last four years, but lower discount rates meant the plans' funded status worsened anyway.
"People may be getting tired of hearing me saying it but interest rates have been the story for the last four years and that's not going to change in 2013," John Ehrhardt, a principal and consulting actuary at Milliman, said in a companion to the report.
By Milliman's estimate, the pension funding deficit would decrease nearly 40 percent by the end of 2014 if only discount rates would stop falling and plans would meet their expected rate of return on their assets.
But that is not the case. Not only are discount rates coming down, plan sponsors are lowering their expected rates of return too. AT&T, for example, lowered its expected return 50 basis points, even after exceeding the old threshold for 2012.
Corporate pension funding is always a complicated issue, made even more so now by, of all things, a highway transportation bill.
Commonly known by its shorthand name, the MAP-21 Act became law last July. It included a provision that lets companies use an average of interest rates over the prior 25 years when determining how much they have to contribute to their plans to meet funding requirements. (The provision found its way into the bill as a revenue-raising mechanism to offset highway spending.)
That effectively lets companies contribute less into the plans, saving them money. In other words, for plan sponsors' purposes, rates went up even as in reality they were going down.
"It's a very awkward relief. I'm not quite sure how anyone came up with this, frankly; you couldn't make it up," said Jon Barry, a partner at Mercer. "In 2012 and definitely in 2013 too, all things being equal, funding is quite a bit lower under this relief."
Not all companies will take advantage of it. Some actuaries say companies that are trying to actively reduce risks in their pensions are unlikely to use it at all.
"You do have plan sponsors in more cash-strapped industries or more cash-strapped companies who will take advantage of it," said Margaret McDonald, a senior vice president and senior actuary at Prudential Financial.
UPS said on Thursday it will face $225 million in pension costs this year, nearly 5 percent of its forecast earnings. Without knowing what treatment the company has chosen, multiple actuaries said it was entirely possible that contribution would be larger but for MAP-21.
Analysts say that either way, those contribution figures are ultimately more important than the discount-rate charges, in that they represent actual cash coming off the books.
"It's important to look at what's an economic result and not just a reported number based on new mark-to-market rules," said Keith Schoonmaker, equity analyst at Morningstar.
(Additional reporting by Scott Malone in Boston and Jilian Mincer in New York; Editing by Steve Orlofsky)
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