QE Adverse Side Effect #1: Corporate Pension Underfunding Hits Record $460 Billion Deficit, A $108 Billion Deterioration IN ONE MONTH

Tyler Durden's picture

US retirees better pray that their Schwab accounts will rise forever and ever, because if they rely on defined benefit pension plans, they are fucked. According to actuarial and consulting firm Miliman, in August 2010, the funded status of the 100 largest defined benefit
pension plans sponsored by U.S. companies dropped by $108 billion to a
10-year low of 70.1%
. Yes, that's a $100 billion + deterioration in one month! The culprit - Ben Bernanke - financial market performance was poor in August, but the main
reason for the decline in funded status was a large decrease in
corporate bond interest rates.
Who would have thought that pushing all markets so far from equilibrium could possibly have an adverse side effect. Soon, once pension funds like the Illinois TRS and others fold, and tens of millions of people who have diligently saved all their lives only to wake up one day and find they have no money left at all, their anger may finally rise and be rightfully directed at its just source: the corrupt slaveocratic inhabitants of the Marriner Eccles building. Expect to hear much, much more about this worst side effect of the Fed's flawed Keynesian solution to all of life's problems.

The assets of corporate pensions relative to their deficits, known as the funded ratio, fell to 70.1 percent in August, also the lowest in at least 10  years, from 75.6 percent the month before, according to the Milliman. Pension plan assets declined $17 billion last month to $1.076 trillion, a loss of 1.12 percent. The median expected monthly return for plans in the index is 0.65 percent for 2010, a yearly return of 8.1 percent.

It gets worse. As Bloomberg reports, "the shortfall is “like a silent heart attack,” said Kenneth Hackel, president of research and consulting firm CT Capital LLC and the former chief of fixed-income strategy at RBS Securities Inc. “People aren’t recognizing the symptoms until the patient falls on the ground.”

Corporate pension plans are a casualty of Federal Reserve efforts to keep interest rates low to prevent the economy from slipping back into recession.

As AA rated company bond yields, a benchmark in determining future liabilities, last month reached the lowest ever, obligations increased $91 billion to $1.54 trillion, Seattle-based Milliman said, without disclosing company names.

Contributions to the 100 biggest corporate pension plans increased to $54.5 billion in 2009 from $29.5 billion the previous year and compares with an average of $38.7 billion for the prior five years, Milliman said in an April report.

Companies may have to spend even more cash to fund their pensions, Hackel said.

“It’s a major, major hit for companies to take,” said Hackel of Alpine, New Jersey-based CT Capital. “Sponsors are going to need to step up their contributions massively.”

Corporate pension plans have deteriorated since the fall of 2008 as the worst financial crisis since the Great Depression caused investments to plunge, eroding the value of pension assets. The Standard & Poor’s 500 Index lost 37 percent that year, while U.S. corporate bonds lost 10.9 percent.

“Liability losses could dwarf even good investment gains,” said John Ehrhardt, a principal and consulting actuary in New York with Milliman. “It’s a cash flow issue, it’s a drag on earnings when you look at the accounting numbers, and it’s a hit to your balance sheet, which can cause all kinds of problems about loan covenants and everything else.”

And here is the data from the horse's mouth:

The funded status of the 100 largest corporate defined benefit pension plans dropped by $108 billion during August 2010 as measured by the Milliman 100 Pension Funding Index (PFI). The funded status decrease was primarily due to a significant decrease in corporate bond interest rates that are the benchmarks used to value pension liabilities. Though not as significant, the financial markets performed poorly in August 2010 as well. As of August 31, 2010, the funded ratio plummeted to 70.1%, down from 75.6% at the end of July 2010. This marks the lowest funded ratio recorded within the last 10 years for the Milliman 100 PFI. The last time the funded ratio was nearly this low was on May 31, 2003, when it was 70.5%.

August's $17 billion decrease in market value brings the Milliman 100 PFI asset value to $1.076 trillion, down from $1.093 trillion at the end of July 2010. The monthly asset performance was a loss of 1.12%. By comparison, the Milliman 2010 Pension Funding Study published in April 2010 reported that the median expected monthly investment return during 2010 on pension assets for the Milliman 100 PFI companies would be 0.65% (8.10% annualized).

The projected benefit obligation (PBO), or pension liabilities, increased by $91 billion during August, moving the Milliman 100 PFI value to $1.536 trillion from $1.445 trillion at the end of July 2010. The change was the result of a 45-basis-point decrease in the monthly discount rate to 4.78% for August (from 5.23% for July).

Over the last 12 months (September 2009-August 2010), the cumulative asset return has been 6.99% and the Milliman 100 PFI funded status has decreased by $162 billion, due primarily to lower trending discount rates. For these 12 months, the funded ratio of the Milliman 100 companies decreased to 70.1% from 77.8%.

What to expect for the rest of 2010

If, for the remainder of 2010, the Milliman PFI 100 companies were to achieve the expected 8.1% median asset return and if the current discount rate of 4.78% were maintained for the duration of the year, we forecast the funded status of the surveyed plans would increase, with a projected pension deficit of $457 billion and a funded ratio of 70.3%.

If asset returns were to increase/decrease by 200 basis points for the remainder of the year compared with the median asset return expectation of 8.1%, the projected year-end funded status would increase/decrease by approximately $7 billion.

If discount rates were to increase/decrease by 25 basis points by the end of the year relative to the current discount rate of 4.78%, the projected year-end funded status would decrease/increase by approximately $52 billion.