The news keeps getting worse for large corporate pension funds.
Just one week after a UBS Global Asset Management survey indicated that U.S. pension funding ratios fell an average 11% in the first quarter and 24% in the past nine months, a Mercer survey found that changes in the value of the assets and liabilities of S&P 1500 companies' pension plans wiped a collective $70 billion off their balance sheets. In just three months, says Adrian Hartshorn, a principal in Mercer's financial strategy group, the group has gone from being overfunded with a funded ratio of 103% to only 99% funded at the end of March.
Hartshorn says the losses won't be reflected in 2008 earnings, because, under U.S. accounting rules, pension costs generally are determined using market data at the end of the prior reporting period. For most companies this means that the 2008 pension expense was based on Dec. 31, 2007, market conditions — prior to the market declines of the first quarter, Hartshorn said.
Companies could be forced to increase cash contributions if the markets don't recover, Hartshorn said. Meanwhile, companies are changing investment strategies to reduce the impact of pension plan volatility on corporate financial statements, according to Hartshorn. Some, for example, are trying to match fixed income durations to their liability durations, investing more heavily in bonds, or for some more sophisticated plan sponsors, by entering into interest rate swaps, says Hartshorn. However, these actions often leave the risk of equity market volatility unaddressed.
“The desire to manage interest rate risk is a step in the right direction,” said Hartshorn. “However, companies need to implement risk management strategies carefully and consider which risk they are seeking to mitigate.”
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