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Rising Interest Rates, Stocks Perfect Weather for Pension Plans

New study by pension expert shows companies moving to 100 percent pension funding.

May 16, 2006
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Five years ago, sinking stocks and falling interest rates created a bad climate in the financial markets, leading some companies to underfund their pension plans.

Today, simultaneous increases in interest rates and equities have created fair weather for companies that offer defined-benefit pensions, helping them to amass enough cash to meet 100 percent of their accrued promises, according to a new study.

Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries, has calculated that the average funding ratio for 365 sponsors of defined-benefit plans in the Standard & Poor’s 500 rose from 91 percent to 100 percent since the end of last year. S&P 500 plan sponsors whose pension assets exceeded their benefits obligations rose from 34 percent to more than 50 percent.

Gebhardtsbauer utilized pension funding data from a December report on the S&P 500 by Credit Suisse First Boston as his baseline. He then applied current interest rates and stock prices to determine the health of the companies' pension plans today.

Pension obligations decrease when interest rates rise because of the way that net present value is calculated. In addition, when stocks go up, companies that have invested pension funds in equities reap the benefit.

In its meeting last week, the Federal Reserve raised short-term interest rates, as it has been doing consistently over the past couple years.

"It’s time to party if you’re a pension plan, but not if you’re trying to buy a house," says Gebhardtsbauer, who announced his study at a pension conference in Washington on Monday, May 15. The event was sponsored by AARP and the Employee Benefit Research Institute.

In the improving financial market climate, the number of S&P 500 plans that are less than 90 percent funded has dropped from 50 percent to 33 percent. The Bush administration, which is advocating pension reform, has said that pensions are underfunded by a total of $450 billion.

That number has likely fallen, but Gebhardtsbauer is not sure by how much. The $22.8 billion deficit at the Pension Benefit Guaranty Corp. has also probably improved.

It’s uncertain whether the brighter pension outlook will affect Capitol Hill negotiations. "They still need to improve the rules," says Gebhardtsbauer. "They still need to tighten it up."

The challenge is striking the right balance. "Companies don’t want to put any more money into their pension plans than they have to," Gebhardtsbauer says.

Businesses want to maintain some smoothing of assets and liabilities to increase the predictability of their payments. The Bush administration seeks to virtually eliminate the practice, saying that it has led to severely underfunded pensions.

Even as the health of some pension plans improve, Congress is working on legislation that would tighten funding rules.

While Washington pursues pension reform, the rest of the country is heading for a retirement savings crisis, according to Hedrick Smith, a Pulitzer Prize-winning journalist. His documentary "Can You Afford to Retire?" broadcasts on PBS on Tuesday, May 16.

"People don’t have the foggiest idea of how much they should save for retirement," Smith said at the Washington conference. "They don’t know the difference between the S&P 500 and the Indianapolis 500."

In his report, Smith portrays the difficulties retirees are having making ends meet, including one who sells his prized gun collection to help make up for 401(k) losses. "It’s enough to make you cry," Smith says.

--Mark Schoeff Jr.

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