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Rate pressures on pensions wipe out billions in profits
February 02, 2013
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WASHINGTON: Pension charges wiped out more than $20 billion in fourth-quarter earnings at major American companies, as persistently low interest rates leave some of those with the largest retiree burdens no choice but to assume they need more money now to cover liabilities later.

Actuaries warn there is little chance for improvement on the horizon for defined benefit pension programmes, as rates linger at historically low levels and the Federal Reserve shows no inclination to raise them. The only hope, they say, is for rates to turn around -though when, no one really knows.

Just between AT&T Inc ($10 billion), Verizon Communications ($7 billion) and UPS ($3 billion), pension accounting has led to massive noncash charges in the last few weeks, and those three are not alone.

It is possible there will be even more before the reporting season ends. Employment lawyers say about 37 per cent of people with retirement benefits still have a defined benefit plan or a mix of defined benefits and a 401(k), with little distinction across sectors.

The problem is an interest rate called the discount rate, a number that companies offering plans use to calculate the present value of their future obligations to retirees -how much they need today, in other words, to pay pensioners tomorrow.

Many large plan sponsors have chosen some version of mark-to-market accounting for their pension plans, which means they need to adjust their discount rate periodically (usually yearly) to market conditions.

When market forces dictate that they assume a lower discount rate, it can create a huge actuarial loss.

“The promises these companies have to their employees hasn’t fundamentally changed at all,” said Kevin Wagner, a senior consulting actuary at Towers Watson. “This is really driven by two things: one is that interest rates have just dropped, that’s all, and secondly, different companies have made different decisions on how they want to account for pension plans.”

Wagner and others said that choice comes down largely to how a company wants to handle its pension risk -take the hits (or someday, the rewards) immediately or stretch them out over time?

In AT&T’s case, for example, lowering its discount rate by 100 basis points led to a $12 billion loss, offset only in part by rising asset values. In UPS’s case, year-end discount rates fell a full 120 basis points.

“Is it something that with just a moderate increase in the economy and interest rates would reverse and actually begin to be a positive on paper? Yes. So we take it seriously but also realize that it is an accounting definition and one that could swing either way,” UPS Chief Financial Officer Kurt Kuehn said in a telephone interview.

AT&T and Verizon are two of the many companies that have adopted mark-to-market pension accounting, which experts have said can be beneficial because it removes the drag of pension losses from future results. Someday, when rates rise, it could also create one-time, pension-driven increases in earnings.

In the meantime, though, it is not helping much. The well-regarded pension consultancy Milliman Inc estimated earlier this month that the country’s 100 largest corporate defined benefit pension plans had a deficit of $412 billion at the end of 2012, up 22 per cent from a year earlier.

 In many cases, strong performance of assets was not enough to offset rising liabilities.

 As the firm noted, pension fund returns have exceeded expectations in three of the last four years, but lower discount rates meant the plans’ funded status worsened anyway.

“People may be getting tired of hearing me saying it but interest rates have been the story for the last four years and that’s not going to change in 2013,” John Ehrhardt, a principal and consulting actuary at Milliman, said in a companion to the report.

Reuters

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