Persistent, Pesky Problems Facing Pensions

by Deidra Krys-Rusoff
Senior Vice President

Equity markets sold off on Friday, but were mixed for the week. The S&P 500 closed out the week slightly higher, returning a positive .45 percent for the week. The Dow Jones Industrial Index ended the week about -.30 percent lower, with energy leading decliners. The Nasdaq returned a strong 1 percent for the week. The euro strengthened against the U.S. dollar, trading at 1.17 euro, the highest level since 2015. The euro rally is based upon comments from European Central Bank President Mario Draghi suggesting an unwinding of the central bank’s quantitative easing. Bond prices rose for the week, with the benchmark 10-year Treasury yield falling to 2.22 percent from last week’s close of 2.33 percent.

If you haven’t heard about government pension funding problems, you must be taking a hiatus from the news. Nearly every week, headlines such as, “CalPERS Gains Great, but Far from Sufficient” and “Connecticut Sinks Deeper in Debt as Pension Returns Lag Target” send shivers down the backs of investors and retirees. What’s not as well known is the underreporting of the $382 billion funding gap in some of the largest corporate pension plans. Bloomberg News reported this week that 186 of the largest 200 defined-benefit plans of companies represented in the S&P 500 are not fully funded, specifically, meaning that they don’t have enough cash on hand to fund 80 percent of the costs of current and future retirees’ benefits. 

This news, however, is less troublesome than in past decades, as there are far fewer defined-benefit plans covering many fewer employees. Traditional corporate pension plans have been declining as companies are shifting the burden of retirement savings to employees through terminating or altering traditional retirement plans and moving to 401(k) plans. Despite this shift, these defined-benefit plan numbers are large enough to impact corporate budgets. For example, General Electric (GE), ended their defined-benefit plan for new hires in 2012, yet still has the largest pension shortfall among its S&P peers, owing a staggering $31 billion. Shortfalls are not exclusively the domain of old-line industrial companies as technology giant Intel rings in with the lowest funded ratio, at 46.6 percent.

How are municipal pension plans fairing this year? The Center for State and Local Government Excellence released their annual update on state and local pension plans and noted that public pensions are better positioned then they were immediately following the economic downturn. Despite better positioning, funding ratios declined to 72 percent in 2016 from 73 percent in 2015. This year, however, should be a better year for municipal plans. Pension plan investment returns have been quite positive year-to-date, which, when coupled with lower investment expectation calculations, should allow pension plans funding levels to stabilize. Even with the better returns, municipalities will need to increase their retirement contributions and continue to consistently meet or beat their investments return goals to return to fully funded status. 

In an interesting development, New Jersey’s state retirement system for civil workers just won the Powerball lottery. New Jersey’s history of pension underfunding has placed increasing financial pressure on the state’s budget, requiring that more cash be set aside to guarantee that the state will be able to pay retirees’ future pension checks. Governor Chris Christie recently signed into law a bill that directs approximately $1 billion per year from New Jersey’s lottery system into the pension plan benefiting teachers, police and other workers. This strategy, however, is no silver bullet. Lottery funds will help to shore up New Jersey’s perpetual pension underfunding, though it will reduce revenue that had been previously directed to cover other parts of the state’s budget, such as universities and healthcare.

Takeaways for the Week

  • Equity markets ended the week mixed: The S&P 500 and NASDAQ were higher and the Dow Jones Industrial Index closed lower
  • The euro closed at 1.17, the highest level versus the U.S. dollar since 2015
  • Corporate pension plans are funded at surprisingly low levels
  • Municipal pension plan funding levels have stabilized since the financial crisis, but at lower levels