Bottom Line: In the end, individuals, either as taxpayers or consumers, will pay the bill.
The reality is just as our children may not ‘have it as good’ as we did, our retirement may not be as ‘good’ as our parents.
The full May 19, 2008 S&P research paper S&P 500 2007: Pensions and Other Post Employment Benefits, complete with issue level data is available here
Equity issues in general are in much better shape with respect to their pensions than the public sector. The reason simply is that they are required to be so under statute.
As a group, S&P 500 issuers returned to their fully funded status with $1.5 trillion in assets, which was $63 billion over their $1.44 trillion in obligations. Funding improved to 104% from 97%, but remained well below the 128% level at the end of Bull Market in 1999. Over funded plans increased to 36% of the issuers, from 23% last year. Discount rates rose for the third year in a row, and now stand at 6.13%, compared to 5.75%, with the change again reducing projected benefit obligations. Estimated pension return rates were basically unchanged, declining 1 bp to 8.02%, but still marked the seventh consecutive annual reduction. The spread between the discount and return rate has now been reduced to 189 pbs from the 303 pbs two years ago, and stands near its fifteen-year average.
The breakdown in U.S. and non-U.S funds has widened. U.S. invested funds, which have 85% of the assets and 83% of the obligations, were over funded by 7.0% in 2007, compared to the non-U.S. funds that were under funded by 8.8%. Asset allocations continue to shift out of equities and into fixed income. In aggregate, U.S. funds of $1.2 trillion reduced their equity allocation to 54.4% from 60.3%, with the fixed income component increasing to 33.9% from 30.0%. Non-U.S. funds of $214 billion shifted in the same direction, with equity allocation decreasing to 56.2% from 59.8%; fixed income increased to 37.7% from 34.6%.
For 2008, companies expect an 8% return. Based on the current domestic and international returns, they are about $100 billion short of that mark. However, the hope is that oil prices may be peaking, and when added to the tax refunds, stimulus package, and 325 fewer basis points courtesy of the Federal Reserve, there will be sufficient time for the market to rebound. We expect pensions to remain fully funded in aggregate this year; however, we also expect that companies will have to contribute a bit more than they are currently expecting to do in order to stay that way.
OTHER POST EMPLOYMENT OBLIGATIONS
The bottom line for OPEBs is that they are also in better shape than their public counter parts, but the condition is only positive in relative terms. Only 43% of the issuers had OPEB funds, which resulted in a 30.7% funding rate; the other 57% had no funds and were totally on a pay-as-you-go basis. While we group pensions and OPEBs together, they have two key differences. First, pensions have the backing of the Pension Benefit Guarantee Corporation, while OPEBs have no such support or fallback position; and second, unlike pensions that have required funding and legal standing, most OPEBs are not regulatory in nature and can be modified either arbitrarily or through labor negotiations. Currently we are experiencing pullbacks in benefits to U.S. domestic employees, as well as fewer workers being covered for benefits. More substantial, a shift in expenses from the company to the individual via increased co-payments and premiums is occurring. We expect these to continue on, as companies continue cost control measures.
From a company prospective, this is a necessary shift. As U.S. economic dominance has shifted, or depending upon the blame factor, deteriorated, the ability of companies to pass along to consumers the costs associated with retirement has significantly diminished. Global pressures have now forced U.S. concerns to scale back their retirement benefits to remain competitive. While the vast majority of companies have the cash resources to fund and pay OPEBs, they actually spent over twice the total OPEB under funding in buybacks last year, the matter is now one of global survivorship. The need to remain competitive within global markets that provide different benefits based on national boundaries are not new, but U.S. companies can no longer afford the disadvantage.
Eventually, the government, in conjunction with the private sector, will be forced to address the matter. The concern is that neither has shown a tolerance for the pain associated with the type of forward action needed. In the end, individuals, either as taxpayers or consumers, will pay the bill. The reality for many potential retirees is that, just as their children may not ‘have it as good’ as they did, their retirement may not be as ‘good’ as their parents.