$20 Billion Club: What’s Next for US Corporate Pensions?

Pension plans of 19 of the largest US corporations are expected to de-risk, receive smaller sponsor contributions, and be overtaken by defined contribution systems, according to Russell Investments.

(March 3, 2014) — As US corporate pension plans improved their financial health last year, the industry can expect big strategic changes and a lightened contribution burden, according to a report by Russell Investments.

Russell’s “$20 billion club” includes 19 US corporations with worldwide pension liabilities surpassing $20 billion. Last year, the group shed more than $100 billion in deficits, thanks to bullish equity markets, rising interest rates, and increased sponsor contributions. The combined shortfall shrunk from $220 billion to $114 billion, the lowest since the financial crisis.

2013 was a critical year, said Bob Collie, Russell’s chief research strategist for the Americas institutional division.

After hitting “peak pension” in 2012—with liabilities the highest they would ever get—”America’s private sector defined benefit system is now officially shrinking,” according to Collie. As it falls, he said, the defined contribution system has progressed in the opposite direction.

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Nearly $69 billion in liabilities fell away last year due to interest rate and actuarial assumption changes alone. The median discount rate used for valuation rose to 4.89%, for instance. Plan sponsor contributions were also exceptionally high for the club at roughly $27 billion—more than double the $12 billion added in 2008.

Russell’s model for a representative open pension plan finished the year strongly at 88% funded. The $20 billion club’s liabilities also fell to $841 billion from $915 billion while assets grew from $694 billion to $727 billion.

“All of those changes have increased the appetite of sponsors to run their plans differently than in the past: more liability-focused; less peer-sensitive; more risk-averse,” Collie wrote in a blog post.

Smaller deficits mean smaller contributions, Collie added. Plan sponsor contributions are expected to drop to $14.3 billion in 2014, according to the report.

Employers are also expected to lean more heavily on liability-driven investing strategies, showing greater efforts to de-risk and maintain their high funded ratios, the report stated. It’s already begun. For example, Ford has adopted “a broad global pension de-risking strategy” to achieve full funding and United Technologies’ has implemented an interest-rate hedge which dynamically increased as funded status improves.

Other members of the $20 billion club include AT&T, Bank of America, Boeing, Dow Chemical, E.I. DuPont de NeMours, Exxon Mobil, General Electric, General Motors, Hewlett-Packard, Honeywell, IBM, Lockheed Martin, Northrop Grumman, Pfizer, Raytheon, United Parcel Service, and Verizon.

(March 3, 2014) — Warren Buffett voiced his concerns about what he sees as growing crises among US public pension plans in his annual Berkshire Hathaway shareholder report.

The 83-year-old business magnate predicted public pensions would continue to plague some government balance sheets. “During the next decade, you will read a lot of news—bad news—about public pension plans,” he wrote.

According to Berkshire Hathaway’s CEO and board chairman, major problems have arisen from empty promises made to employees and the complexities of actuarial calculations.

“Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford,” Buffett said. “Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them. Unfortunately, pension mathematics today remain a mystery to most Americans.”

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However cryptic the accounting, public pension ratios, liabilities, and management fees have increasingly drawn the attention of mass media.

Rhode Island’s $8 billion plan was 58.2% funded and had an unfunded actual accrued liability of $4.5 billion as of 2012. Both North and South Carolina have been under scrutiny for high—and allegedly unreported—management fees. The two pension plans of the bankrupt city of Detroit faced $3.5 billion of debt and $11.5 billion in unsecured liabilities as of July 2013. The Illinois pension plans are currently wrestling a deal with lawmakers to relieve of over $100 billion of underfunding.

Buffett had been aware and warned of such perils of poor pension investing since October of 1975.

In a 19-page memo to Katharine Graham, the then publisher of the Washington Post, Buffett outlined the “irreversible nature of pension promises.”

“The first thing to recognize, with every pension benefit decision, is that you almost certainly are playing for keeps and won’t be able to reverse your decision subsequently if it produces subnormal profitability,” Buffett wrote in 1975.

“Rule number one regarding pension costs has to be to know what you are getting into before signing up,” he continued. “Look before you leap. There probably is more managerial ignorance on pension costs than any other cost item of remotely similar magnitude. And, as will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs.”

Buffett also showed concern for accounting practices: “Actuarial thinking simply is not intuitive to most minds. The lexicon is arcane, the numbers seem unreal, and making promises never quite triggers the visceral response evoked by writing a check.”

The Washington Post‘s pension fund was around 141% funded when the paper was sold to Amazon in August last year.