Tuesday, April 23, 2013

The Shortfall in Corporate Pension Plans

There is a story on Reuters this morning about the widening gap in corporate pension plans between what retirees are owed and the assets which are actually available to pay.

According to the story, pension consultant Towers Watson calculated that at the end of 2012 there was a shortfall of $295 billion in the top 100 corporate pension plans between assets and liabilities.  This represented a +17% increase in the funding gap from the end of 2011.

A large part of the problem stems from today's historically low interest rates.  Companies are required to calculate the present value of future benefits by using a discount rate based on corporate bond yields.  The lower the discount rate, the higher today's present value.

However, another huge part of the problem that corporate pension plans are facing is the fact that they have been steadily reducing their exposure to stocks in favor of bonds and alternative asset classes. 

Here's what the article notes:

Over the last few years many corporations have been gradually adjusting their portfolios to reduce investment risk relative to liabilities, shifting from public equities to fixed-income and alternative investments.

Since 2009, average allocations to equities have fallen 10 percentage points, while allocations to fixed-income investments have risen by eight percentage points. However, the shift away from equities slowed in 2012, according to the report.

"Of the 95 companies that reported target asset allocation strategies for 2012 and 2013, only three reduced their target equity allocations by 10 percent or more, versus 16 for 2011," Towers Watson's report said.


As I have written numerous times in the past, this makes no sense.  Due to the long-lived nature of their liabilities, pension funds should be using a very long time horizon in making their asset allocation decisions.  And the historical record is clear:  with very few exceptions, stocks have delivered returns far in excess of bonds, and most alternative assets as well.

Yet with their eyes firmly fixed in the rear view mirror, and the memories of the 2008-09 credit crunch still fresh, plan sponsors continue to add to assets that have virtually no chance of meeting actuarial assumptions  (bonds) away from the asset class that historically has delivered the needed returns (stocks).