Driving costs higher this 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, according to a Standard & Poor’s (S&P) report.
With funding status on the wane and thus higher pension obligations – the present value of the future payments for both current and future retirees – pension spending goes on the rise. “We estimate that through June 18th, the pension funds in the S&P 500 have made almost $100 billion in the market, while their costs have gone up $113 billion. The result is that funds are in a slightly worse situation than they were at year-end 2002,” Howard Silverblatt, senior equity index analyst at S&P, said in a statement
However, for the full year, S&P points to a potential for a turnaround. Assuming the S&P 500 closes 2003 at 1030 and there is a slight rise in the discount rate, the status of aggregate pension funding could improve slightly from an underfunding of $212 billion at the end of 2002, to an estimated $180 billion underfunding at year-end 2003. The result to the S&P 500 should be a reduced cash contribution to the pension fund, thereby improving corporate cash flow.
The implications of improved pension funding status have sweeping effects for the broader markets, S&P found. “We predict that pension earnings for many companies will show a loss for this year due to the accounting methodology that averages in several years; this is the so-called ‘smoothing affect’,” explained Silverblatt. “S&P Core Earnings, which last year subtracted out these pension gains that were ‘smoothed’, will therefore be adding them back in this year.”
This has reduced thevolatility of S&P Core Earnings – corporate accounting and finance concepts tracked by S&P. Like a reverse domino effect, this is a direct result of the pension trust, which is, in turn, a direct result of the markets and the pension funds investments.