Discount rates fall and shortfalls increase for the $20 billion club in 2016

According to their latest SEC filings, the pension assets and liabilities of the largest U.S.-listed plan sponsors (we call them the $20 billion club) increased in 2016. The combined pension deficit of the 19 corporations rose from $177bn to $189bn, mainly due to a fall in the discount rate used to value liabilities.

A mirror image of 2015

A new paper describing the development of the pension balance sheets at these corporations is available here. Here are some of the highlights:

• As has been the case in most recent years (2008 being a notable exception), the single biggest factor driving plan experience has been interest rates. The median discount rate used to value liabilities fell from 4.4% to 4.1%.
• The impact of the fall in the discount rate was offset somewhat by investment returns a little above expectations. Investment returns ranged from 4.7% to 12.0% for the corporations that report on a calendar year basis, more than enough to cover the growth in liabilities resulting from the passage of time.
• Even though there was a substantial net deficit of assets below liabilities, contributions by plan sponsors in 2016 were only slightly above the value of new benefit accruals. Roughly half of the corporations made discretionary contributions to their U.S. plans in 2016, and half did not. Notably, Federal Express announced in December an extra $1bn in discretionary pension contributions, to be made in 2017 and financed by debt issuance.

• 2016’s experience was almost an exact mirror image of 2015, a year in which discount rates rose, investment returns were disappointing and contributions were slightly below the value of new benefit accruals.
• Despite the drop in discount rate in 2016, the year-end liability of $902bn remains below 2014’s high point of $933bn. Unless there is a substantial fall in interest rates, 2014 may prove to be “peak pension,” the point at which DB plan liabilities reached their high.
• Even if total liabilities are past their peak, total pension assets may continue to grow, as steps are taken to address the $189bn deficit. With 2016 total assets less than 5% below 2014’s level, strong investment performance in 2017 could see a new high.
• The total net periodic pension cost for the 19 corporations rose in 2016 from $21.5bn to $22.2bn. The pattern varied greatly from case to case, however, depending on the approach taken to (a) the amortization of gains/losses and (b) selection of a yield curve for service and interest cost calculations.
• Marking to market tended to result in a higher pension cost in 2016 as the impact of market factors (such as the fall in discount rate) was recognized more quickly. The total loss recognized by the six corporations who use a mark-to-market approach was $9.9bn, approximately 4% of year-end liability value. The loss recognized by the 13 corporations who do not mark to market averaged approximately 2% less of their liability value.
• For those corporations using a full yield curve approach, the effect in 2016 was an average reduction of roughly 15% in service cost plus interest cost combined.

The full research paper is available here.