Dark Pension Clouds Gather on the 2004 Horizon

The number of S&P 500 companies underfunded at the end of the year would rise to 340 from 334 in 2002(See  Companies Pour $46 Billion Into Pensions in 2002 ). Additionally, pension expenses for S&P 500 companies will increase to $19 billion this year from $4 billion last year, then skyrocket to $26 billion in 2004, and $37 billion in 2005, according to a report authored by Credit Suisse analyst David Zion.

Overall, the aggregate shortage among S&P 500 companies isexpected to rise 10% this year to $247 billion from $225 billion in 2002(See  S&P: $206 Billion Pension Shortfall in 2002 ).   Echoing these concerns is Standard & Poor’s analyst Howard Silverblatt, who told Reuters pension underfunding at S&P 500 companies will widen to roughly $220 billion at the end of the year from $212 billion last year.

The rainy forecasts comeeven though the S&P 500 is up 13% this year, equaling positive returns for equity investments of roughly 11%.   The problem though is not the performance of pension funds this year, but will one year’s increases be enough to make up for three years of declines?

Part of the explanation, Zion said, is that many companies face growing pension obligations because of retiring workers and suggested that 30 S&P 500 companies would have pension plans underfunded by more than 25% of their market capitalization at the end of 2003.   Further, four companies – AMR Corp., Delta Air Lines Inc., Goodyear Tire & Rubber Co. and McDermott International Inc. – will have pension plans underfunded by more than their entire market values.

Also sending costs higherthis year are plan liabilities through the effect of interest rates on economic assumptions.  Interest rates have again been hit, decreasing 30 basis points year-to-date, bringing with them the benchmark discount rate and thus the decline in the benchmark’s funded status.  

Help may be on the way as the US Congress currently plans to temporarily allow companies to value pension obligations with a discount rate tied to the yield on long term, high grade corporate bonds rather than a rate tied to the 30-year Treasury bond. That would result in a higher discount rate, smaller pension obligations and reduced funding requirements (See  Pension Stability Act Grabs US Senate Committee Ok ).