We No Longer Have a Pension Crisis (Sort of)

General Electric did something amazing in 1998. A roaring stock market left the pension fund covering its former employees with a huge surplus. In effect, GE had set billions of dollars more than its number-crunchers figured it would need to pay future pensioners. An accounting rule let the company count part of that surplus as profit. Of GE's $13.8 billion profit that year, more than $1 billion came from its pension plan.

It wasn't alone. Forty percent of Northrop Grumman's profit in early 1998 came from its overfunded pension. IBM booked a $454 million gain. Boeing took a $121 million boost. Ten companies in the S&P 500 had a pension surplus of nearly $80 billion.

These stories sound crazy today. All we've heard about for the last decade is how underfunded corporate pensions are. "More than two-thirds of the companies that make up the S&P 500 have defined-benefit plans, and as of last quarter only 18 of them were fully funded," TIME magazine wrote just a year ago. In December 2012, corporate pensions in the S&P 1500 were underfunded by $557 billion, according to consulting firm Mercer.

But things changed in 2013. A new report by consultants Towers Watson estimates corporate pensions are now 93% funded, on average. In another report, consultants at Mercer said pension plans among S&P 1500 companies are now 95% funded, up from 74% a year ago. The half-trillion deficit a year ago has been reduced by more than 80%, to less than $100 billion.

Two things fueled this turnaround.

Stocks just had their best year since the mid-1990s, up nearly 30%. That was more than enough to offset any decline suffered in bonds. I think we got so used to a decade of dismal returns that a lot of people forecasting the pension crisis forgot this could occur. A year ago, I interviewed Joseph Dear, then chief investment officer of CalPERS, the nation's largest pension fund, who said this about market returns:

It's not been so great for the past ten years, but if you look at big cycles in investment and see 10-year returns from equities relatively low, what we've seen after that is a return to better returns, a reversion to the mean. So I think there is a reasonable basis to be confident.

That's exactly what happened.

Two, and a little more complicated, is that rising interest rates reduced the present value of pension plans' future liabilities. Pensions use a "discount rate" -- an interest rate typically linked to corporate bond yields -- to convert future obligations into a present value. The lower that rate is, the higher a pension's liabilities are. And with interest rates at all-time low in recent years, that discount rate has been incredibly low, pushing up the present value of pension funds' liabilities. 

But with interest rates now rising, the present value of future obligations is coming down. Towers Watson says the average discount rate used in corporate pensions rose to 4.8% in 2013, from 3.9% in 2012. When I asked Dear about low discount rates last year, he replied:

In a super-low rate environment like we have today, liabilities are definitely bigger. But are interest rates going to stay low? Is the 10-year Treasury going to stay at 1.6% indefinitely? I doubt it. So it's going to go up and the interest rates will go up and even those who want to do the yield curve will see liabilities coming down.

That, too, is exactly what happened. In June, Mercer estimated that rising corporate bond yields reduced S&P 1500 pension obligations by $150 billion. Yields have increased sharply since then -- the 10-year Treasury bond rose from 2.2% in June to 3% today -- shrinking liabilities even further. If interest rates keep rising this year, and most analysts expect they will, pension funding levels could keep rising.

Is our corporate pension crisis over? Sort of. I think a more accurate observation is that these things constantly move in cycles. Pensions looked underfunded in the early 1990s. Then they were way overfunded in the late 1990s. Then they became strained in the early 2000s. Then they were overfunded again by 2007. Next came the half-a-trillion-dollar shortfall last year, and today, we're back to fairly healthy levels. Funding calculations rely on assumptions. Those assumptions are usually wrong, and they can change dramatically overnight. There's almost never a time when pensions are perfectly funded at just the right level and stay there forever, nor should there be. Any investor it in for the long run has to accept big ups and downs. It's just part of the deal. 

So be happy corporate pensions are doing better. But realize we'll be back to Crisisville before long. 

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

No Pitch

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  • Report this Comment On January 07, 2014, at 3:38 PM, 8bravo wrote:

    Thanks for the reminder to keep the long sight, Morgan. Did you write this article in a haste? I barely see so many typos in your work ;-)

  • Report this Comment On January 07, 2014, at 5:41 PM, xetn wrote:

    What about all the unfunded government pensions: Social Security, states, counties and cities?

  • Report this Comment On January 07, 2014, at 5:44 PM, TMFHousel wrote:
  • Report this Comment On January 07, 2014, at 6:21 PM, jlclayton wrote:

    Good to understand more about company pensions and how their future obligations are calculated. This is another good reason why any financial information should be viewed in context over several economic cycles to be the most relevant.

  • Report this Comment On January 07, 2014, at 8:17 PM, sciencedave wrote:


    Those are good points and I like your articles. Corporate pensions currently appear to be better funded post GM bailout as many companies besides GM re-structured their current or future pension obligations.

    But recent Detroit bankruptcy (partly due to long-term outsized pension obligations) and Illinois current pension crisis indicate still unsolved obligations. These probably will not be solved by looking at changing interest rates any time soon.

  • Report this Comment On January 08, 2014, at 12:30 AM, divebonaire wrote:

    Corporate pensions may be on better footing but government and public pensions and obligations are still a disaster.

  • Report this Comment On January 08, 2014, at 12:43 AM, BabyBoomer1946 wrote:

    Possibly, one reason the Corporate pension plans are looking better is because they have succeeded in cutting benefits, raising retirement ages, and cutting health insurance.

    Amid record breaking profits, a few years age, Caterpillar completely quit their Defined Benefit plans. Now they do a 401K matching.

    I receive benefits as a retired teacher, in Illinois. The reason our retirement system is underfunded is widely known. The legislature decided, years ago, not to contribute their share into our system. If they had, it would be solvent, today and for many years out.

    Both government and corporate retirement systems are backing away as fast as they can, from Defined Benefit plans. I understand why they are doing so, but many are also cutting salaries and benefits. So, workers have less disposable income and need to save more. I see a major problem in the future, as this generation of workers approaches retirement.

  • Report this Comment On January 08, 2014, at 11:34 AM, mdk0611 wrote:

    Boomer -

    1. Just how does cutting health insurance benefit corporate defined benefit plans?

    2. You think you would have gotten those benefits in collective bargaining if the legislature knew they would have to have raised taxes to "contribute their share" into the system before their next election (or the one after that)?

    Morgan -

    I totally agree with "sort of". Clearly better than a year ago, but then again a year from now they could be right back into a hole.

  • Report this Comment On January 08, 2014, at 6:48 PM, BabyBoomer1946 wrote:


    To answer your comments..

    1) Part of our Teacher Retirement is a contribution to our Health Insurance. Some corporations do the same. Several of my friends are retired from Caterpillar, who had promised them continued health Insurance benefits. However, Cat has diminished them as well..with higher co-pays and larger deductibles, as well as a ceiling lifetime benefit.

    2) I don't quite know what you are getting at. Of course the legislature would be aware that salaries increase over the years. As salaries increase, so do our payments into the system. Part of the problem with funding is the fact that the baby boomers are retiring...a large group. This should not have been a surprise to anyone.

    If you think teachers are overpaid, that is another issue. Starting salary for a teacher in this area is around 30,000. Of that 9% goes to the retirement system. It used to be 8%, but was raised years ago to keep system solvent. Our Teachers Retirement is a separate system...self supporting..and is not under State of Illinois control. The funds really are there and are invested.

    We do not pay into Social Security and do not get Social Security Benefits. We do pay into Medicare and get those benefits.

    I have to add that I know that I am fortunate to have a decent retirement. Many people who worked hard for many years do not.

    On the other hand, most of my friends in the corporate world made significantly higher salaries than I did, had more disposal income and were able to contribute to a 401K with company matching some portion. Some had stock options as well. For many years, I felt secure knowing that I would have a decent retirement benefit. That fact is part of the reason I stayed at my job until retirement.

  • Report this Comment On January 09, 2014, at 7:58 PM, sciencedave wrote:

    The teachers retirement system according to news articles is underfunded by close to 40 billion. That apparently is the major problem. And it is primarily funded by the state.

    Also teachers are paid well in Illinois. In fact they have the distinction of being the second best state in terms of pay in the US. California is first in pay.

    Contrary to popular belief, many teachers do in fact have million dollar retirements waiting for them. 70% of salary for life after 35 years....do the math.

    Industry employees...not so much. Pensions are gone for most. Social security is much less than 70% of salary....more like 25% at best.

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