Friday, April 8, 2011

Funded Status of Corporate Pensions Improves Due to Increased Funding

Each month, Mercer does an analysis of the funded status of pension plans sponsored by S&P 1500 companies. Based on the Mercer study, the aggregate funding deficit as of March 31, 2011 was about $213 billion, down from $256 billion a month earlier. Mercer said that one of the primary reasons for this smaller deficit is that pension plan sponsors continue to make significant contributions to the plans. This is especially true for corporations with high quality debt where the current extremely low cost of borrowing for these companies has caused many to choose to borrow to fund up those plans. Also notable in the Mercer study is that the aggregate funded status for the same plans increased from 81% to 87% during the 3-month period ended March 31, 2011.

What's going on here? While I haven't had the opportunity to discuss this issue with all of the finance heads, many of whom are presumably the ones who are making this decision, let's consider a very plausible rationale. Suppose you sponsor a pension plan that is underfunded by $100 million. In simple terms, this leaves you with a $100 million liability on the balance sheet. Now, if you turn around and borrow that same $100 million (or some piece of it) at today's very low rates, you 'move' the liability on the balance sheet from the pension plan to more standard corporate debt, and you do it a low rate.

Why might this be good? In and of itself, it might not be, but suppose you use that new level of funding to help de-risk the pension plan. You are now taking what many consider to be a risky, highly volatile (this has been addressed over and over again here and in many other places) liability and replacing it with a stable, less risky liability. In today's world, where risk is bad and risk management is king, this is highly desirable. My employer has been at the forefront of such risk management efforts in pension plans since our inception.

Frankly, it's not just funding that has decreased deficits and increased funded statuses. Equity investments have generally performed well year-to-date and underlying discount rates have remained relatively stable.

I haven't seen the gory details of the Mercer study, but I must wonder to what extent the Pension Protection Act (PPA) funding rules have been behind these contributions as well. With plans being as poorly funded as they have been recently, and CFOs having the knowledge that PPA does require particularly rapid (7-year) funding of the underfunded, might they not be simply opting to throw cash at the plans when the cost of cash is low? Better, perhaps to do it this way, than to fund only when it is required when their borrowing costs may be higher.

So, the large corporate world seems to be getting this under control. If only sponsors of public pension plans could fix their underfunding as easily.

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