Strong asset growth last year is expected to help large corporations raise the funding levels of their defined benefit plans and substantially reduce underfunding, according to a new report from Moody's Investors Services Inc., New York.
The Moody's report studied 50 U.S. non-financial companies with the largest defined benefit plans for which it issues credit ratings, and Moody's it estimated they could reduce their aggregate underfunding by about $75 billion for 2010.
A $75 billion reduction would be “substantial,” Wesley Smyth, vice president and senior accounting analyst for Moody's, said in an interview. “We'll have to wait for the final numbers when the 10-K statements are issued,” he said.
The 50 large plans tracked by Moody's had a modest decrease in aggregate underfunding between year-end 2008 and year-end 2009, dropping to $178.9 billion from $188.3 billion.
A report from Mercer, however, indicated the outlook is less rosy for the pension plans of companies in the Standard & Poor's 1500 index.
Mercer estimated that aggregate underfunding worsened last year for the broader group of companies. The aggregate deficit rose to $315 billion from $229 billion in 2009, while the funded status dropped to 81% from 84%, according to a Jan. 5 Mercer news release.
“The funded status deficit would have been worse if not for the estimated $43 billion that companies disclosed they expected to contribute in 2010,” the release said. Mercer said the aggregate funded status, when measured on a monthly basis, could be volatile, ranging from 84% at the end of March 2010 to 71% at the end of August.
Moody's expects aggregate funding levels to range from 85% to 89% for 2010, an increase from 79% in 2009, according to the report.
Although each of the 50 plans was underfunded in 2009, Mr. Smyth said “their funded status is better than most.” The Moody's report shows that almost all of the 50 made contributions to their pension plans in 2008 and 2009 and that most companies have investment-grade ratings.
Several large companies tracked by Moody's already have announced contribution plans for 2010 and/or 2011. For example, Exelon Corp., Chicago, said early this month that it would contribute $2.1 billion in the first quarter, raising its funded status to 89% by the end of 2011 vs. 77% last year for its $8.66 billion plan. Honeywell International Inc., Morristown, N.J., said in November that it would contribute $1 billion in 2010 and another $1 billion in 2011 to its $13.8 billion plan.
Although the Moody's report expected asset growth to help raise funding levels when the corporate pension accounting for 2010 is completed, it also predicted a “modest rise” in pension obligations will offset some of these gains.
“Pension contributions will be going up in 2011, which could strain liquidity,” the report said. “Absent further market rebounds and/or further legislative relief, required cash contributions will increase.”
The Moody's report predicted that “many companies will be issuing debt in the coming years to contribute to their pension funds,” noting that the “wild ride experienced in pension funding levels since 2008 has left an indelible mark” on companies with DB plans.
Although Moody's can't forecast how pension funding would affect credit ratings until 10-K statements are filed, “it is safe to say that rising funding levels are beneficial to credit, all other things held constant,” the report said.
“Underfundings remain and continue to place downward pressure on ratings,” the report added. “Due to the continued modest improvement, we do not anticipate downward rating adjustments solely as a result of continued underfundings.”
Mr. Smyth said he “couldn't find any rating actions in the past six to nine months for the top 50 (companies) where pension was a material contribution factor.”
Moody's and Mercer agree that 2011 could herald strategic changes in investment strategies for DB plans.
“We expect more companies will be issuing debt in 2011 to reduce pension underfundings and take advantage of related tax benefits,” the Moody's report said. “We also expect that companies will shift asset allocations to reduce equity and interest rate risks in the future.”
If the funded status of corporate pension plans improves due to rising stocks or rising bond yields, “2011 could see a marked acceleration in the shift away from equities into bonds for corporate pension plans,” the Mercer release said.