US Corporate Pensions Remain Underfunded

With interest rates so low, a massively rising equity market still has not been able to bring the U.S. corporate pension system anywhere close to fully funded. This means that companies will have to keep adding more funds to compensate their pensioners because of the shortcomings of the financial markets.

Perhaps the good news here is that the gap continues to narrow. According to the BNY Mellon Institutional Scorecard, the funded status of the typical U.S. corporate pension plan rose by 2.9 points in October to 84.7% funded.

BNY Mellon has some insight on this issue. After all, it currently has about $28.5 trillion in assets under custody and/or administration, and BNY Mellon also has $1.6 trillion directly in assets under management.

The newest report noted that corporate pensions are now up 2.4% so far in 2015, but that is after they went into negative territory in September. Another bit of good news here is that public plans, as well as foundations and endowments, both exceeded their respective monthly return targets. The decline in rates led to an increase in liabilities of 0.8%, while assets appreciated 4.2%.

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BNY Mellon maintained a positive stance for October. The company said:

For the first time since mid-summer, investors finally saw relief from market headwinds, as equities of all flavors had a strong month. Corporate defined benefit plan sponsors felt the combined effects of both appreciating asset values and relatively stable liabilities, which led to funded status increases for the typical plan.

Here is where the pension status still has some caution: public plans are short on their year-to-date return target by 5.6%, and short against the one-year return target by 6.9%. Again, through time a pension shortfall requires solvent companies to effectively fill the gap on a make-whole basis. That is not all at once, but through time it is expected to balance out.

An additional concern would be that BNY Mellon showed that asset returns for endowments and foundations are still down 53 basis points over the past year. That is actually behind the spending plus inflation target by 5.1%.

Another concern is that investors are increasing their risk exposure to make up for the shortfall. BNY Mellon said:

Investors are starting to come around on risk asset exposure, which definitely helped the equity markets this month. High yield credit and emerging market debt also saw gains — up 2.7 and 2.6 percent, respectively. Inflation has been virtually non-existent year-to-date, and is negative over the past 12 months. The rise in asset values with controlled inflation particularly benefited typical public defined benefit plans, endowments and foundations. We hope to see this trend continue in the months ahead.

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If you consider the Great Recession and the impact it had on all retirement funds, this might not sound too bad. Still, 24/7 Wall St. reviewed some of the past BNY Mellon Institutional Scorecard reports, and this 84.7% funded status is nowhere close to the highest level of recent years. Here are some randomly selected dates from recent years:

  • July 2013 was 88.2% funded.
  • January 2014 was 91.0% funded.
  • July 2014 was 90.8% funded.
  • December 2014 87.3% funded.
  • March 2015 was 87.2% funded.
  • June 2015 was 87.8% funded.

It is unlikely that the U.S. pension system will ever be fully funded, at least through time. That being said, many U.S. companies are looking to scale down or eliminate their pension plans to lower their long-term (or endless) liabilities. As their pension shortfalls remain wider, or if a market scare ever crushes that relative funding status, companies are likely to keep looking to lower, modify or eliminate their pension plans.

Now consider that the bull market is approaching its seventh year. If the markets remain flat, the funding gap widens because pension systems are expected to grow to keep up with their liabilities. If the markets enter into the redline with losses, that funding gap becomes even worse. The Federal Reserve’s zero interest rate policy and extremely low interest rates have made all pension gains in recent years rely on equities and other non-government debt asset classes.

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