Management

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

Dear CFO/Treasurer, 

Your predecessors made generous pension promises to U.S. employees. It's fallen to you to find a way to pay for them. Hard luck. 

Plunging bond yields have caused your company's pension liabilities to balloon . The ratio of assets to liabilities of the top 100 U.S. defined benefit plans is close to the lowest in four years, according to Milliman, a consulting firm. 

Funding Shortfall
US corporate pension plans have fallen further into deficit due to low interests rates
Source: Milliman
Nb. Shows funded ratio for 100 largest corporate defined benefit pension plans

Pensions are also a problem in Europe, and plenty of companies are at a similar loss to know how to fund those obligations. Still, deficits seem to be a bigger focus for management and investors there. In contrast, many of you have cut pension funding, with Congress's encouragement.

Pension plan deficits aren't like the other debt on your balance sheet -- they tend to be volatile. And when the economy started to recover following the financial crisis, you probably hoped the problem would go away by itself. That seemed possible in 2013 when discount rates rose, equity markets surged and your plan's funding looked better.

Unfortunately, the chances of rate rises kept shrinking. Futures traders were almost unanimous at the start of the year that the Fed would hike rates by December. Now they put the chances at less than 50 percent.

Your pensions are in a sorry state -- plans of S&P 500 companies are almost $500 billion in deficit, according to BNY Mellon Fiduciary Solutions.

Returns over Retirements
S&P 500 companies have prioritized share buybacks and dividends
Source: Bloomberg, BNY Mellon, S&P Dow Jones Indices

Let's be honest: putting cash into your pension plan hasn't been a priority. You're unlikely to have received a letter from a long-term minded activist investor encouraging you to do that. Instead, you saw how buybacks helped your rival's stock and you wanted a piece of the action. Given the choice between funding the pension plan or announcing a buyback or takeover, that capital allocation decision looked a no-brainer.

Competition for Cash
U.S. companies have spent big on share repurchases yet still have large unfunded pension liabilities
Source: Company reports and Bloomberg
Nb. Many of these companies have also taken action to fund/de-risk their pension plans. Deficits are negative numbers, obviously.

I know what you're going to say: "I'm not obliged to put any money into the pension plan! We're fully funded. Ask the government!"

You could argue that. You shouldn't.

It's true that since 2012 Congress has allowed U.S. companies to apply a "smoothed" discount rate to value their pension liabilities. The new measure is based on bond yields prevalent during the past 25 years, rather than the 24 months previously. It's like financial repression didn't exist.

With a wave of legislators' magic wand, your mandatory pension contributions were suddenly lower and your pension plan's funding status improved, at least in the eyes of the government. And, surprise, U.S. companies with large pension plans have, on average, cut their contributions to pension plans by half since 2012.

Funding Holiday
Thanks to Congress, many companies haven't had to fund their pension plans recently
Source: Milliman
Nb. Shows data for 100 public companies with the largest defined benefit plan assets

Though some of you chose to keep putting more than the minimum into the pension plan, others boasted they'd use the cash freed up by pension smoothing for buybacks.

But we both know this was bad legislation. It didn't make your actual pension liabilities any smaller, nor did it have any impact on the size of the deficit you are obliged to record in your financial statements. It just let you kick the can down the road for a few more years. 

What some of your investors don't know is that doing nothing about the pension is costing them money.

For one thing, trying to de-risk a pension plan -- by transferring the liability to an insurer -- is costlier when the plan already has a large deficit than trying to do so than when it's fully funded. In hindsight, 2007 or 2013 might have been a good moment to take action. Pity only a few of you did.

But that's water under the bridge now. More importantly, you'll be aware U.S. companies have to pay insurance premiums to the Pension Benefit Guaranty Corporation.

Those premiums, which ensure retirees get paid what's owed them even if your company files for bankruptcy, are set to rise sharply in coming years -- something some of you are furious about. After rising threefold in the past nine years, they're set to hit 4.1 percent of any unfunded liability in 2019. Pension plan contributions will cut the premiums your company has to pay, and are tax deductible.

It's not as though doing this would leave you short of cash: companies in the S&P 500 outside the financial industry have about $1.45 trillion on their balance sheets.

Alternatively, why not copy General Motors and borrow money to fund the pension deficit. Credit-rating companies might view such a move as neutral because you are increasing one kind of borrowing (by issuing bonds) to reduce another (pension liabilities). 

These decisions aren't easy, of course. It's not your fault that employees are living longer or the return on your pension plan assets will probably be lower

Your friends at Citigroup will have told you equity investors increasingly consider pension deficits when considering how much to pay for your company's stock.  Meanwhile, if your acquaintances at Goldman Sachs are right, investors have soured on stock repurchases this year.

So it really could be time to pause those buybacks and start plugging the pension deficit. Maybe give it some thought?

Yours sincerely,

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. By reducing the discount rate companies use to calculate the value of those obligations in today's money.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net