Funding Improvements Shouldn't Nix Pension Contributions

New study suggests pensions plans' funded status is improving this year, but still warns companies against reducing contribution levels.

This week, Fitch Ratings released a new study which supports the idea that pension plans' funded status is improving this year, as interest rates rise and bond prices fall. Fitch evaluated the year-end 2012 funding of pension plans at 224 U.S.-based companies outside the financial services industry.

The bad news in the Fitch report is that even though plan assets grew 5 percent in 2012 and contributions to the plans increased, the median funded status of U.S.-based pension plans fell to 73.8 percent, from 74.4 percent in 2011. The analysis revealed that two-thirds of the plans (148) are less than 80 percent funded, a trigger point requiring further scrutiny to determine whether the plan is "at risk." One-quarter of the plans (57) are between 80 percent and 90 percent funded, and fewer than 10 percent of the plans (19) are more than 90 percent funded. Fitch identified the oil and gas, retail, and telecom sectors as standing out for their low funding status; companies in each of these industries had a median funded status of 70 percent or less.

The good news is that Fitch identified falling disount rates, which increase plan liabilities, as a key driver of the plans' declining funded status. The median discount rate fell from 4.8 percent in 2011 to 4.1 percent in 2012. This is good news because it suggests that as interest rates have risen in 2013, plans' funded status should have improved as well.

"Interest rate volatility causes large changes in benefit obligations—a 1 percent rise in the discount rate can lead to a 10 to 20 percent decline in the present value of a company's liabilities," the report states. Nevertheless, it report adds: "While Fitch believes near-term prospects signal potential funding improvements, companies contributing the minimum under recent funding relief [MAP-21] may face a day of reckoning in the coming years due to the potential for a steep accelerating of funding requirements.

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