Mark Baker, ASA, CAIA
Recent Posts
Defined Benefit Funding Levels, Contribution Relief, and Unintended Consequences
At the close of 2012, pension funding levels for a broad set of defined benefit plans sat in the high-seventies. Sponsors had weathered the massive equity losses of the 2008 global financial crisis (GFC), and subsequent plummeting interest rates, and they seemed poised to recoup their losses. The markets would be kind to investors over the next half-decade with the S&P 500 nearly doubling in price, generating a cumulative total return in excess of 100%, and outpacing long duration fixed income (a proxy for pension liabilities) substantially.
Figure 1
So how did sponsors fare? Not as well as one might expect, given the data above.
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Just a few months ago, UPS announced to 70,000 non-union workers that their pension benefits would be frozen. In order to manage a deficit in U.S. pension obligations of nearly $10 billion, affected workers will stop accruing pension benefits on January 1, 2023. On that date, the package carrier will instead begin contributing 5-8% of salaries into 401(k) savings accounts.
UPS is not alone in making difficult decisions that impact defined benefit (DB) plan funding, and in turn, corporate earnings, balance sheet stability, and the futures of thousands of long-serving employees. With collective unfunded pension obligations among S&P 1500 companies totaling $391 billion at the end of February 2017 (Mercer) and interest rates languishing at historic lows, a majority of employers are reckoning with the same dilemma.
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The predictability and smooth-functioning of bond performance during the recent, protracted period of low interest rates has led to record corporate bond issuance.
Investors seeking a safe place for their assets have moved into bond markets. And there has been no shortage of bonds to buy. But these “safe investments” that have provided protection from a volatile stock market can themselves become traps without thoughtful consideration of rebalancing and exit plan strategies.
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