Pensions Further Hammered By December Discount Rate Drop
10 January 2009 - 7:35AM
Dow Jones News
Corporations that had been expecting to receive some pension
relief by lowering their plans' costs ended up with a year-end lump
of coal last month when a key factor used to calculate their
liabilities turned sharply against them.
The discount rate that is used to determine the present value of
a company's pension liabilities took a steep fall south in the
final weeks of 2008, compounding the problems facing companies that
were already dealing with declining asset values in their retirees'
plans. The change in the rate was so swift and so large that
several Wall Street veterans said they couldn't recall a similar
episode during their careers.
"What we observed in the last two months of 2008 was probably
the most precipitous drop in the discount rate in such a short
time. It exceeded what you might see in a year," said Ethan Kra,
chief retirement actuary at consulting firm Mercer. "It's
unprecedented in my experience, and I've been in this business
30-plus years."
The Citigroup Pension Liability Index, a widely used discount
rate benchmark, dropped 125 basis points in December alone,
finishing the year at 5.87%, a slide that followed on the heels of
an 89-basis-point drop in November. Because the index made most of
its gains in the early fall, it ended the year down only 61 basis
points from December 2007. But that decline will still result in an
average pension plan liability increase of about 9% to 10%,
estimates Kra.
Companies must use whatever the discount rate is at the end of
their fiscal year to calculate their current pension liabilities,
or costs, and those liabilities climb as the rate falls. Because so
many companies end their fiscal year with the calendar year, the
year-end rate will affect a large proportion of U.S. corporations'
pension expenses.
The discount rate drop comes at a particularly tough time for
corporate pension plans, because the assets they own have been
beaten down by poor market performance in 2008, leaving many
companies with underfunded plans. Now rising liability costs will
compound that further.
It's also an unpleasant turnaround because earlier in the fall
-- at a time when companies are usually forming financial plans for
the coming year -- the discount rate was up for the year. That led
some corporations, ranging from mechanical power transmission
manufacturer Altra Holdings inc. (AIMC) to Xerox Corp. (XRX), to
predict that their liabilities would be eased by the discount
rate.
"The interesting question is whether what happened in December
will have an impact on 2009 guidance companies gave as recently as
a few weeks ago," says Caitlin Long, head of the pensions solutions
group at Morgan Stanley.
Altra Vice President of Finance Todd Patriacca says executives
know that the discount rate has worsened since it last gave
guidance to investors in November, but the company hasn't finished
analyzing the impact it will have on its pension obligations. Xerox
declined to comment, citing its quiet period until earnings are
announced in two weeks.
The discount rate is based on the yields of corporate bonds
rated AA or better. The reason it fell so rapidly in December, say
analysts, is that rating agencies downgraded some higher-yielding
AA corporate bonds from the financial services sector, including
those of Citigroup Inc. (C) and Goldman Sachs Inc. (GS).
The effects of rising liabilities and declining assets in any
given year are absorbed by U.S. corporations the following year, so
the hurricane that ripped through pension plans in 2008 will start
showing up in 2009. That's when underfunded pensions begin to weigh
on balance sheets and compensation expenses, triggering debt
covenant changes, higher borrowing costs and lower earnings.
-By Lynn Cowan, Dow Jones Newswires; 301-270-0323;
lynn.cowan@dowjones.com
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