Monday, December 22, 2008

Is the Bailout Hurting Pension Plans?

Interesting post over at the Peterson Institute by Jacob Funk Kirkegaard from last month (he nailed it) with the secondary effects of the bailouts / flooding of liquidity into the system on corporations pension plans and balance sheets:

As the financial crisis deepens, the world’s central banks and financial authorities have gained broad support for their efforts to reintroduce liquidity to the credit markets, get banks to lend again and bring down spreads and bond yields. But these sensible and indeed required steps to avoid a repeat of the 1930s may come with a drawback: a rapid decline in corporate bond yields, which threaten to produce rapidly rising funding shortfalls in defined benefit (DB) pension funds.
The reason is that the present value of these pension liabilities are discounted at roughly the yield of a AA Corporate bond. While markets sold off this year hurting plans, the plans did benefit from a higher AA Corporate rate (spreads widened significantly), which reduced the present value of their liabilities (i.e. future benefit payments).

Looking below at the 10 year AA bond yield over the past year, along with the present value for paying $1 million per year over the next 30 years at this rate (this is obviously a simplified version of the "real world") we can see that the cost of liabilities has bounced back significantly (~20%) over the past few months. In other words, corporations reporting with a 12/31 year end vs. a 9/30 year end will show two very different sets of liabilities, which directly impacts their balance sheet.

Back to Jacob:
In today’s financial crisis, US corporations and state and local governments with a DB pension plan have so far been hit in different ways. The large recent declines in global stock markets have hit pension plan asset valuations hard, and without doubt the Pension Protection Act (PPA) of 2006 (for corporations) as well as the gradual introduction of accrual accounting methods for state and local government pension funds by the Governmental Accounting Standards Board (GASB) will require future increases in pension plan sponsors’ pension contribution levels.

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