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Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

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  • Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

    Corporate Pension Fund shortfalls weigh on recovery (Update 2)

    Dr. William Strauss heads up FutureMetrics.com, a group of economists and business experts who provide economics, statistics, finance, and accounting analysis and forecasting to businesses and government. Dr. Strauss sent me the firm’s August 2009 Pension Status Report yesterday. I found it so startling that I thought I’d better pass on the highlights to you right away, along with a summary of the email discussion that he and I had on it.

    Corporate pension funding shortfalls are a major operating cash flow problem for the corporations that experience shortfalls because by law corporations must finance pension funds to 100% over time. Pension fund shortfalls were problematic for most companies even before the financial crisis. Post crisis, the number of pension funds that are not 100% or better funded has increased from 67.6% in FY 2008 to 92.7% in FY 2009 ending in June. The median funded level is a mere 46%.

    The pension funding shortfalls crisis initially appeared between 2002 to 2003 from a combination of falling stock prices and interest rates. The combination turned thousands of previously fully funded pension plans into underfunded plans.

    Why? A pension plan’s liabilities are for payments that are made decades in the future. To evaluate the adequacy of a plan’s funding, discount obligations to a present value.
    Background: Present value is calculated on the assumption that a dollar received today, as income or other payment, is worth more than a dollar that is received in the future. A dollar received today can be put to work immediately whereas a dollar received in the future cannot be put to work earning money until a future date. If the dollar earns four percent today and in the future, $1 today will return $1.04 in one year, so $0.96 today is $1 in the future. In a low interest rate environment, this fact is critical: the higher the rate of interest, the lower the present value today. Conversely, the lower the rate of interest, the higher the present value today.
    Now consider the pension fund obligation versus the asset value side of the funding equation, the money that the pension fund earns versus the money the pension funds owes.

    The value of a dollar owed decades from tomorrow is a smaller obligation than a dollar owed tomorrow. But expand the time frame out to decades and the level of obligation compounds with each passing year. When interest rates are low, as they are today, pension funding calculations do not discount a pension’s future obligations nearly as much as when interest rates are high. As a result, the net present value of the obligations increases in a low interest rate environment.

    An adequate funding level requires that either asset values rise from increased contributions and rising stock prices, or liabilities decline via rising interest rates or greater participant attrition. An environment of low interest rates and low stock prices is a double whammy for pension funding because the net present value of liabilities increases as the net present value of assets falls.

    As bad as the 2002 to 2003 period was for pension funds, the current crisis is nearly three times worse from a returns perspective, with no letup in sight.

    Falling stock prices and low interest rates hammers return on corporate pension fund assets.
    Estimated annualized are -23% for the median pension fund versus -8% at the bottom of the previous crisis.
    Pension Fund Exposure

    What's the total under funded pension plan exposure for U.S. corporations? What percentage of pension funds are underfunded and how much money does the aggregate level of underfunding represent?

    Corporate pension funds appear to have been in decent shape before the financial crisis. FutureMetrics’ analysis shows that even before the crisis the majority of pension funds were in trouble.

    The first chart below shows the distribution of funded levels for the 2007 and 2008 cohorts for July 2008 to June 2009 fiscal year ends. The chart also shows the best-fit probability distribution.

    FY 2008


    FY 2009
    Dr. Strauss says, "We recalculate the funds’ liabilities using our proprietary algorithm which uses a benchmark discount rate based on U.S. long treasuries and the median of firms’ salary inflation rates. You will note in the chart that compares the discount rate assumptions with long treasuries (page 9) that firms are discounting very aggressively. The reported median funded level is 69% (page 4). After our “adjustment” we calculate the median funded level at 46%!

    From a total dollar liability standpoint, only 32.4% of the funds were 100% or better funded in 2007. That fell to 6.3% in 2008. That means that 92.7% of corporate pension funds are under-funded.

    The shortfalls must, by law, be paid by corporations, so 92.7% of U.S. corporations with pension fund obligations will have to divert cash into pension funds and away from operations or investing in growth. That has implications for the financial health and long run viability for U.S. corporations, particularly those that are already in trouble financing debt and other obligations.

    I asked Dr Strauss if he'd run the numbers for us to estimate the total shortfall in dollars so we can estimate the total liability to corporations' cash flows. His reply starts off: “These are big numbers.”
    Aggregate total pension liability for all U.S. corporate pension funds, based on data from plans representing 92% of U.S. corporate pension assets, is $1.48 trillion while aggregate total assets is $1.15 trillion, leaving a shortfall of $325 billion.
    There are two possible outcomes for unfunded pension liabilities.

    One, markets recover to 2007 levels to bring pension fund asset levels back up to even FY 2008 levels when 32.4% of the funds were 100% or better funded versus 6.3% in 2009. That will allow more companies to meet their pension fund obligations. We believe that this scenario is unlikely as the debt financed FIRE Economy continues to deteriorate over the next ten years. Even if that does happen, that still leaves 67.6% of plans under funded. That’s the best case.

    Two, markets will not recover and pension fund promises will not be kept. More firms will go bankrupt and allow the Pension Benefit Guaranty Corporation (PBGC) to compensate pensioners. But the level of payouts that the PBGC makes are typically much lower than the original pension promises. Recent airline bankruptcies are indicative. At the time the PBGC took over Delta Airline’s pension plan, for example, it had $1.7 billion in assets and more than $4.7 billion in liabilities. The PBGC's estimated that it is liable for only one third of the $3 billion shortfall. Back of the envelope, pilots who worked for Delta for decades will receive about half the money they expected to receive, that is, their own money.

    Firms that do not go bankrupt have to finance shortfalls out of operating cash flow. Two obvious questions arise. One, how can firms rehire if they are diverting funds to finance pension fund obligations? And two, how much of a liability does this represent?

    If 92.7% of U.S. corporations have pension funds that are less than 100% or better funded, and the total aggregate shortfall is $325 billion, and total quarterly after tax profits of all corporations in Q1 2009 (according to the U.S. Department of Commerce: Bureau of Economic Analysis) is $1.05 trillion ($4.2 trillion annualized), and Q1 2009 Corporate Net Cash Flow (BEA) is $1.5 trillion ($6 trillion annualized), then the total aggregate unfunded pension fund liability represents 8% of profits and 5% of cash flows annually.

    Medical Pensions: 81% underfunded

    Pension plan underfunding is a serious problem, but medical pensions funding is worse.

    Strauss explains why: “Corporations can walk away from medical pension promises without any real legal impact. That is why they are so unfunded. But as you rightly point out, that will shift more of the burden to the government programs.”

    Even the 95th percentile medical pension funds are less than 60% funded
    The aggregate total medical retiree benefit obligation based on 92% of U.S. corporate pension assets is $318 billion, but aggregate total assets is only $62 billion. The shortfall is $256 billion, or 81% of liabilities.
    Only 35% of medical pension plans have any funding. The other 65% have no assets at all. Of those that are funded, 39.7% are than 25% funded, and only two firms are funded greater than 100%.

    Only 35% of medical pension plans have any funding. The other 65% have no assets at all.
    In the coming years, corporate pension fund shortfalls will consume operating cash flows. This will reduce hiring and slow recovery. In the long run, as taxpayers, we will likely pick up that tab for underfunded medical pensions in the coming years. Then again, compared to the $9 trillion in deficits that the CBO recently estimated for the next ten years, this latest represents another two or three shovels full of public debt heaped on top of a mountain of it that started life as a private sector commitment.

    Click on the link August 2009 Pension Status Report to read the full report.

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    Last edited by FRED; 09-04-09, 01:01 AM.

  • #2
    Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

    what about STATE and Municipal pension funds? We taxpayers are REALLY on the hook for those.

    Comment


    • #3
      Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

      Click on the link August 2009 Pension Status Report to read the full report.
      Looking at that report, it seems that two of the best retirement funds for 2008 were Merrill Lynch and Morgan Stanley.

      What the heck? I thought those two guys blew up last year.

      P.S. I wasn't looking at that report, but at another report on that site: The Annual Best and Worst Pension Plans for 2008. Sorry for the confusion.
      Last edited by ThePythonicCow; 08-30-09, 05:05 PM. Reason: add P.S.
      Most folks are good; a few aren't.

      Comment


      • #4
        Re: Corporate Pension Fund shortfalls weigh on recovery

        Yeah, this ought to be fun to watch!
        Exacerbating this whole debacle is the fact that most funds have an assumption for future growth of the pension fund of around 8-10%. Sure, no problem. Sign those managers up for gamblers anonymous.

        Then let's add in how the Fed's have helped out corporations with their tax laws.
        Overfund the pension and get hit with a penalty. So, during the heyday of the stock market going wild, what do you think the companies were doing with regard to funding? That's right, they were intentionally holding back funding that could have gone to pensions because they would be hit with a penalty if the pension over-performed. Why would the U.S. gov't do this? TAXES! Pension payments are pre-tax.
        The gov't intentionally puts corporations in a box vis-a-vie tax policy. Typical crap from the tit-heads that put out policy.

        "
        Research Project # 16: Tax Policy and Occupational Pension Plans


        Research Project # 16: Tax Policy and
        Occupational Pension Plans

        Research Paper: Impact of Tax Policy on Coverage
        and Funding of Corporate‑Sponsored Pension Plans

        Researcher: Jinyan Li
        October 2007
        Executive Summary
        Corporate-sponsored defined benefit (DB) plans and defined contribution (DC) plans are referred to as “registered pension plans” (RPPs) under the Income Tax Act. The decline in DB coverage and the under-funding of DB plans have been well reported elsewhere. This Report examines the extent to which tax policy has contributed to these problems in the case of corporate-sponsored DB plans. It relies primarily on existing empirical data and secondary literature.
        Part 2 of this Report discusses whether the decline of the coverage of corporate DB plans is related to, or caused by, major changes in tax policy, such as the universal contribution limit for all tax-assisted retirement saving plans, the contribution limits, and reductions in tax rates for individuals and corporations.
        The Report concludes that the 1991 tax reform has clearly reduced the relative advantage for DB plans by integrating the tax treatment of DB plans, DC plans and RRSPs and by increasing the tax-sheltered contributions to DC plans and RRSPs. Empirical data show an increase in DC plans and RRSP coverage during the era of decline in DB coverage. It is clear that tax policy has encouraged the expansion of RRSPs and DC plans. However, it is not clear whether, or if so, to what extent, such expansion has occurred at the expense of DB plans. It is true that small DB plans have tended to disappear, and some may have been replaced by a DC plan or group RRSP, but the question remains whether these DB plans would have disappeared regardless of the option of DC plans or group RRSPs. RRSP contributions made by individuals who are not covered by DB plans (e.g., new workers, part-time workers, the self-employed, and workers in smaller firms) are not resulted from shifting from DB plans. Therefore, the growth of RRSPs and DC plans may represent additional retirement savings, especially in cases where individuals with higher earnings tend to contribute to both RPPs and RRSPs.
        Lowering marginal tax rates for individuals and corporations can be a double-edged sword. Lower tax rates result in more after-tax income, and thus more funds available for making contributions. On the other hand, the value of the tax assistance is determined by the marginal tax rate. Lower rates mean less value for the tax assistance, and thus, less tax incentive. There is no conclusive empirical evidence, however, on the extent of the decline in DB coverage being related to the lowering of tax rates.
        Part 3 discusses the role of tax policy in respect of the funding of DB plans. More specifically, it examines the role of the 10 per cent surplus rule, the lack of flexibility in funding DB plans, and the foreign property rule.
        The effect of the 10 per cent rule is to deny corporate sponsors their tax deductions for the contributions to “over-funded” plans, resulting in a “tax cost” to the employer (the amount is dependent on the applicable corporate income tax rate). The purpose of this rule is to allow moderate amount of surplus to be retained in a plan while limiting the government revenue cost associated with deferrals of tax on amounts over and above those required to fund the promised pension benefits. Empirical evidence shows that:
        • It is not clear that the 10 per cent rule is the sole, or major, cause of contribution holidays taken by corporate sponsors in the late 1 990s;
        • there is no observable relationship between the number of contribution holidays taken by plan sponsors and plan funding ratios;
        • the percentage of under-funded plans that did not take contribution holidays was sometimes greater than those that did take contribution holidays between 1994 and 2003;
        • ****but 45 per cent of under-funded plans would have completely eliminated their current actuarial deficit if contribution holidays had not been taken.****

        MY ASTERISKS ABOVE!

        Overall, the 10 per cent rule is counter-intuitive: it does not encourage companies to “save for rainy days”; it is, thus, not an effective “smoothing” mechanism.
        The Income Tax Act currently recognizes DB plans and DC plans and provides limits on various aspects of a DB plan that can be registered for tax purposes. It does not encourage any innovation in designing corporate pension plans, such as “cash balance plans” recognized by the US Pension Protection Act of 2006. A cash balance plan may violate the benefit accrual requirements for DB plans.
        Part 4 of the Report suggests a re-evaluation of the pension tax policy in light of changing environment for corporate pension plans. Although no exact data can pinpoint the impact of the 10 per cent surplus rule on the funding status of DB plans, this rule is too rigid and fails to function as a buffer for companies whose financial position changes dramatically from year to year. The surplus limit may be raised. In light of the increasing popularity of DC plans and remaining relative advantages of DB plans in managing pension risks, it is also worth considering to reform the tax rules so that they can accommodate “cash-balance” plans that have features of both DB plans and DC plans."

        My parting comment would be all companies are going to have "dramatically changing financial positions" in an economic crisis which encapsultes all the years since 2000. The freaking morons in charge of tax policy could care less about ensuring companies have a workable solution to pension funding, it's all about feeding the beast.

        Comment


        • #5
          Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

          Originally posted by doom&gloom View Post
          what about STATE and Municipal pension funds? We taxpayers are REALLY on the hook for those.
          Not to mention federal ! Those guys are the only fund legally running at what amounts to zero funding ... for Social Security and Medicare.
          Most folks are good; a few aren't.

          Comment


          • #6
            Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

            Excellent anaysis, but the underfunded pension problem will have a solution, if recent events portend anything. The plan, as shown, is to simply steal the assets of the troubled corporations and default on the bond holders and the pensioners, alike. There is no problem--we have no rule of law.

            Http://hiddenmysteries.net/geeklog/a...459&mode=print

            Comment


            • #7
              Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

              Originally posted by ThePythonicCow View Post
              Not to mention federal ! Those guys are the only fund legally running at what amounts to zero funding ... for Social Security and Medicare.
              The Feds will just (try to) print their way out ofit, or absorb it into that
              fiasco they call HC "reform" to make it more of a "pay as you go program".

              But the states cannot print so they will tax tax tax till the cows come home.

              Comment


              • #8
                Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                This is just another example, a good one at that, of how the FIRE economy simply does not work.

                Comment


                • #9
                  Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                  How many years? Seems to me just one maybe two. What do you think?

                  Comment


                  • #10
                    Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                    Originally posted by rabot10 View Post
                    How many years? Seems to me just one maybe two. What do you think?
                    How many years for what? It's difficult to see what your eyes were looking at when you posted that query over the internet .
                    Most folks are good; a few aren't.

                    Comment


                    • #11
                      Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                      Originally posted by doom&gloom View Post
                      But the states cannot print so they will tax tax tax till the cows come home.
                      Some of the states can't do that. There is an upper bound to what rate you can tax your citizens and actually increase tax revenue. Past that point, tax revenue declines due to a cratering "legal" economy and due to what economy there is moving out of state or onto the black market or underground.

                      States such as California have huge pension fund liabilities and hopelessly declining tax revenues.


                      At least the federal government can tax cow farts if they get desparate (dang, that's not a joke.)
                      Most folks are good; a few aren't.

                      Comment


                      • #12
                        Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                        Originally posted by dummass View Post
                        Excellent anaysis, but the underfunded pension problem will have a solution, if recent events portend anything. The plan, as shown, is to simply steal the assets of the troubled corporations and default on the bond holders and the pensioners, alike. There is no problem--we have no rule of law.

                        Http://hiddenmysteries.net/geeklog/a...459&mode=print
                        There is another solution, hyperinflation. Even if the return on assets is lower than inflation, the liabilities can be funded with depreciated dollars.

                        Comment


                        • #13
                          Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                          Originally posted by bpr View Post
                          There is another solution, hyperinflation. Even if the return on assets is lower than inflation, the liabilities can be funded with depreciated dollars.
                          Yep. That's what happened in Russia as I understand.

                          "Here's your monthly pension. Have a nice cup of coffee."

                          What I expect to cause massive howls of rage will be when the government cancels adjusting federal pension benefits for inflation.

                          Disclaimer: my Dad's going to be one of those. I'm trying to prepare them.

                          Comment


                          • #14
                            Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                            Originally posted by bpr View Post
                            There is another solution, hyperinflation. Even if the return on assets is lower than inflation, the liabilities can be funded with depreciated dollars.
                            There is another solution. Pandemics.
                            Jim 69 y/o

                            "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                            Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                            Good judgement comes from experience; experience comes from bad judgement. Unknown.

                            Comment


                            • #15
                              Re: Corporate Pension Fund shortfalls weigh on recovery - Eric Janszen

                              Originally posted by Jim Nickerson View Post
                              There is another solution. Pandemics.
                              Did EJ's state of Mass. pass that law $1000/day fine if they don't vaccinate? or was that a hoax?

                              Comment

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