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Big Ben’s Big Bite Out of Corporate Pensions

It’s not just state and local governments that are now grappling with huge pension problems.

Big companies like Lockheed Martin (NYSE:LMT), ExxonMobil (NYSE:XOM), General Motors (NYSE:GM), Alcoa (NYSE:AA), Raytheon (NYSE:RTN), Dupont (NYSE:DD), AT&T (NYSE:T), Caterpillar (NYSE:CAT) and Chevron (NYSE:CVX) are battling pension problems, too. And the Federal Reserve’s low rate policies are to blame, the country’s top consultancies warn.

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The Federal Reserve’s historically low interest rate policy is taking big bites not just out of bank deposit accounts and seniors’ wallets, but also big chunks out of the country’s 100 biggest corporate pension plans, creating record deficits in these pensions, says consultancy Milliman.

That means companies will experience an increase in pension problems, because the Federal Reserve has already indicated its intent to keep rates low until the unemployment rate hits 6.5%, Milliman notes.

Historically low rates have deepened the pension funding deficit in record amounts for these plans in 2012, Milliman says, with the top 100 US-based plans on average funded just 76.4% as of the end of last year. Usually plans need to be 80% funded to be considered healthy.

Telecom giant AT&T has already warned in an SEC filing it would book a $10 billion charge for the fourth quarter due to its pension- and retirement-benefit plans, and Verizon (NYSE:VZ) has warned it may book charges in the last quarter of 2012 as well due to its pensions.

A year of ballooning pension shortfalls has the 100 plans’ deficit now at $411.8 billion, $74 billion higher than it was as of year-end 2011.

That’s the largest annual funding deficit in the dozen years Milliman has conducted this analysis.

And that shortfall comes even though the plans had a decent year of returns on assets largely due to improving equities, posting a $90 billion gain, or a return of 9.3%, Milliman says.

The shortfall came from the liability side of the balance sheet, as low interest rates created a $164.8 billion increase in the plans’ pension benefit obligations, Milliman’s John Ehrhardt, co-author of the study, says. .

"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," Ehrhardt said in a statement.

Even though these 100 corporate pension plans have beaten their expected returns on assets for three of the last four years, Milliman’s John adds, the liability losses from plunging interest rates more than offset the investment gains. The companies book the deficit as a charge against shareholder equity on their balance sheets. The study was done by Milliman’s Ehrhardt, along with sharp number crunchers Jeremy Engdahl-Johnson and Zorast Wadia.

The 100 plans have total assets of $1.336 trillion, and liabilities of $1.748 trillion.

Human resources consultancy Mercer found the same record pension deficits.

Mercer has reported that the aggregate deficit in pension plans at the S&P 1500 companies rose by $73 billion to a record year-end deficit of $557 billion as of Dec. 31, 2012. That’s way up from the total deficit of $484 billion a year earlier. The S&P 1500’s funded ratio came in at 74%, up from a record low of 70% at July 31, 2012, but still slightly below the 75% funded ratio on Dec. 31, 2011, Mercer says in a Jan. 3 press release.

Mercer also found that even though the equities in the pension plans posted about 16% growth, in the broad US equity market, plunging rates have pounded other assets in the plans, such as corporate bonds.

“Despite US and non-US equity indices outperforming expectations, interest rates on high-quality corporate bonds declined by more than 80 basis points in the calendar year, driving discount rates down and plan liabilities up significantly, with the overall result a significant decline in funded status for most plans,” asserted Jonathan Barry, a partner with Mercer’s retirement consulting group, in a statement.

Barry adds: “We also saw wide fluctuations in funded status through the year – with the aggregate funded status peaking at about 82% at the end of March, and hitting a low of 70% at the end of July – the largest month-end deficit we have seen since we began tracking this information.”