Sharply lower interest rates are rapidly boosting pension obligations faced by companies, outweighing the benefits from a rising stock market in recent months, Reuters reported, citing a Credit Suisse First Boston report released on Tuesday.
The report is sure to concern finance chiefs at Detroit’s Big Three car makers and large component makers, burdened by the pension costs of legions of long-living retirees who enjoy generous benefits awarded in more prosperous times.
Reuters noted that corporate pension plans were a source of much discontent in corporate America at the end of last year and earlier this year largely due to the dismal stock market which pummelled pension assets.
But the stock market — up 20% from its March lows — has pushed a typical pension portfolio with 65% of its assets invested in stocks and the remaining in fixed income assets, up 8.5% since the start of the year, CSFB estimates, according to Reuters.
The news agency, citing CSFB, said that pension obligations have grown roughly 10% since the start of the year, outpacing the growth from the improving stock market, thanks to the dramatic drop in interest rates.
When interest rates fall, the discount rate used to calculate pension benefits companies must pay out in today’s dollars also falls. That, in turn, increases pension obligations, Reuters explained.
The double blow of tumbling stock markets and interest rates at record lows left pension plans at companies in the Standard & Poor’s 500 underfunded by $US216 billion at the end of 2002, CSFB said, according to Reuters.
The news agency said that, in September, CSFB estimated that the funded status of pension plans in the S&P 500 would improve by about $37 billion between 2002 and 2003 if the plan assets grew by 8.5% and the discount rate rose by 25 basis points in 2003.
But, Reuters added, since the start of the year, Moody’s Aa corporate bond yield — which tracks closely with discount rates used to value pension plans — has dropped 79 basis points. Assuming the same drop in the discount rate means pension plans in the S&P 500 would shrink by another $95 billion, CSFB estimates.
It would also cut earnings by about $11 billion for the S&P 500 between 2003 and 2004, Reuters said.