Pension Pain

10/29/2012


The pension shortfall for S&P 500 Index companies at the end of 2011 stood at a record $355 billion, up 45% from a year earlier. That shortfall equates to 37% of S&P 500 profits last year, or more than the combined stock-market values of Microsoft ($28; MSFT) and McDonald's ($88; MCD).

The picture wasn't always so bleak.

Pensions for S&P 500 Index companies were in the black from 1999 through 2001 and most recently in 2007, when the surplus topped $63 billion. In 2007, the funding ratio (pension assets divided by obligations) stood at a healthy 104%. But by 2011 the funding ratio had slumped to 79%, down from 84% a year earlier and below the 10-year average of 87%.

PENSION STATISTICS FOR S&P 500 COMPANIES
Pension plans for S&P 500 companies are woefully underfunded. In 2011, the deficit hit a record $354.7 billion, up 45% from a year earlier. While plan assets rose 4% to $1.32 trillion, pension obligations jumped 10% to $1.68 trillion. The funding ratio (plan assets divided by obligations) dipped to 79%, well below the 10-year average of 87%. Pension funding has been impacted by mixed returns on stock investments and a sharp decline in interest rates, which have pushed discount rates lower.
Pension
Assets
($Tril.)
Pension
Obligations
($Tril.)
Deficit Or
Surplus
($Bil.)
Funding
Ratio
(%)
Estimated
Discount
Rate
(%)
Estimated
Return
Rate
(%)
S&P 500
Total
Return
(%)
2011
1.32
1.68
(354.7)
79
4.7
7.6
2.1
2010
1.27
1.52
(245.0)
84
5.3
7.7
15.1
2009
1.16
1.42
(260.7)
82
5.8
7.8
26.5
2008
1.10
1.41
(308.4)
78
6.3
8.0
(37.0)
2007
1.50
1.44
63.4
104
6.1
8.0
5.5
2006
1.47
1.51
(40.3)
97
5.8
8.0
15.8
2005
1.32
1.46
(140.4)
90
5.1
8.1
4.9
2004
1.27
1.43
(164.3)
89
5.8
8.3
10.9
2003
1.11
1.28
(164.8)
87
6.1
8.4
28.7
2002
0.95
1.17
(218.5)
81
6.6
8.6
(22.1)
2001
1.09
1.09
3.0
100
7.1
9.2
(11.9)
2000
1.24
1.01
226.0
122
7.4
9.2
(9.1)
1999
1.27
0.99
280.0
128
7.4
9.1
21.0

The growing gap between assets and obligations partly reflects lower returns on pension assets. In 2011, estimated pension returns declined for the 11th straight year, falling to 7.6%, versus the 10-year average of 8.1%. Stung by volatile stock markets, many pension funds have become more conservative in recent years, moving into bonds as interest rates sank to historic lows. Last year the typical pension held roughly 48% in stocks, down from 61% five years earlier.

But we can't blame everything on shrinking returns. Low interest rates have weighed on the discount rate used to calculate the present value of pension obligations. The lower the discount rate, the higher the present value of future obligations.

The average discount rate for S&P 500 companies declined for the third consecutive year in 2011, falling to 4.7%. And at the end of September, the average discount rate had dipped to about 3.9%, according to the pension consultant Mercer. Since 1999, the rate has averaged 6.1%.

S&P 500 SECTOR ANALYSIS
Roughly $104 billion, or 29%, of the S&P 500 pension deficit of $354.7 billion for 2011 comes from the industrial sector, reflecting massive underfunding at General Electric ($21; GE) and Boeing ($73; BA). Based on the funding ratio, the energy sector is in the worst shape at only 68%. Sectors with relatively healthy pension plans include financials and technology.
% Of
Total
Pension
Deficit
----------- 1-Year Change -----------
2010
Funding
Ratio
(%)
Sector
Pension
Assets
(%)
Pension
Obligations
(%)
Deficit
(%)
2011
Funding
Ratio
(%)
Consumer Discretionary
10
2.4
8.3
35.1
82
77
Consumer Staples
7
(6.2)
(1.6)
21.0
83
79
Energy
10
2.3
10.8
34.3
73
68
Financials
7
4.1
11.3
122.7
94
88
Health Care
7
0.3
6.6
37.1
83
78
Industrials
29
(2.7)
6.3
52.0
84
76
Materials
9
2.1
9.7
40.2
80
75
Technology
7
(0.1)
1.9
14.2
86
85
Telecom Services
6
6.0
14.3
71.4
87
81
Utilities
8
11.0
14.1
28.0
82
80
S&P 500 Pensions
100
1.1
7.7
44.0
84
79
Source: Standard & Poor's.

Courtesy of the government, relief is coming. In July, U.S. lawmakers said companies could calculate discount rates using a 25-year average rate, as opposed to the two-year average previously mandated. According to Standard & Poor's, the change could boost the discount rate by more than a percentage point

The pension-funding relief should last through 2016 and save billions of dollars annually. Consider General Electric ($21; GE), which now plans to contribute $400 million to its pension in 2012, down from a prior estimate of $1 billion. Of course, there is no free lunch. Many companies with underfunded pensions will have to make up shortfalls in future years.

Overblown concerns?

Despite the ugly numbers, some experts view the pension shortfall as manageable because corporate America is cash rich, generating enough cash flow and income to satisfy its obligations. Moreover, as companies move away from pensions and toward 401(k) plans, they shift more of the retirement burden to employees. Finally, some companies have offered workers buyout payments to pare obligations.

PENSION STANDOUT AND STINKERS

Immediately below we list 10 stocks with healthy pension plans. All 10 have funding ratios higher than sector averages. In addition, excluding financial stocks, the companies' cash positions and 12-month cash flow and net income exceed their pension deficits.

In contrast, the bottom five companies have relatively weak pensions, characterized by funding ratios below sector averages. Moreover, all five have deficits that outstrip their cash position, cash flow, and earnings.

--- Funding Ratio ---
Deficit Or
Surplus
($Mil.)
Cash &
Equiv.
($Mil.)
Cash
Flow
12 Mos.
($Mil.)
Net
Income
12 Mos.
($Mil.)
Company (Price; Ticker)
Company
(%)
Sector
Avg.
(%)
Healthy Pensions
Aetna ($44; AET)
86
78
(834)
3,144
2,721
1,832
Apache ($83; APA)
97
68
(5)
361
10,028
3,344
BB&T ($29; BBT)
110
88
216
NA
NA
1,834
CF Industries
($206; CF)
86
75
(110)
1,383
2,206
1,744
Chevron ($109; CVX)
70
68
(5,387)
21,463
38,896
26,633
IBM ($191; IBM)
89
85
(10,365)
12,254
20,337
16,261
J.P. Morgan Chase
($41; JPM)
113
88
1,589
NA
NA
19,320
Merck ($46; MRK)
87
78
(1,935)
17,450
12,884
6,736
Target ($63; TGT)
96
77
(132)
1,442
5,569
2,937
Visa ($137; V)
93
85
(56)
7,471
4,508
1,362
Weaker Pensions
Boeing ($74; BA)
75
76
(16,600)
10,307
5,125
4,381
Dow Chemical
($29; DOW)
71
75
(6,644)
4,130
4,680
2,196
Du Pont ($45; DD)
66
75
(9,289)
3,556
4,679
3,492
General Dynamics
($66; GD)
61
76
(3,992)
2,540
3,338
2,453
Lockheed Martin
($92; LMT)
67
76
(13,324)
3,802
3,029
2,832

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