Rising US bond yields offer relief to corporate America's pension plans

Traders work on the floor of the New York Stock Exchange, (NYSE) in New York.
Brendan McDermid | Reuters
Traders work on the floor of the New York Stock Exchange, (NYSE) in New York.

The swift rise in U.S. bond yields in February may be whipsawing some stock market portfolios but it may bring relief to corporate America"s largest pension plans.

For pension funds, rising interest rates can generate more investment income to cover their obligations to pay pensioners.

The prolonged low-rate, low-volatility environment since the 2008 financial crisis posed a challenge for pension fund managers. Not only were returns on bonds low, but the market value of their liabilities was rising, reducing the so-called funding ratio of pension funds.

Rising bond yields can be good for pension plans because it can lower the required annual cash infusions while still meeting their liabilities, said Michael Schlachter, a partner at pension fund advisor Mercer Investment Consulting in Boulder, Colorado.

The estimated aggregate funding status of pension plans sponsored by S&P 1500 index companies increased by 3 percent in January to 87 percent at the end of the month, as a result of both an increase in discount rates on liabilities, tied to bond yields, and a rise in equity markets to a new record, according to Mercer.

Last week"s volatile stock markets worldwide were accompanied by surging bond yields though which worked in favor of pension funds.

Across America"s largest 1,000 companies, 491 offer defined-benefit plans which pay a fixed pension, and these plans have most of their assets in fixed income, followed by equities, then other assets like private equity and cash, according to Willis Towers Watson.

As annual reports are published throughout February, the average funded status of the plans, or the gap between what corporations owe for their pension plans versus what they have set aside for the obligation, will likely show the first year-over-year increase in four years.

"Continued rises in interest rates, equity values, and contributions could further augment funded ratios in 2018," said Michael Moran, chief pension strategist at Goldman Sachs Asset Management in New York.

Helping pensioners

Rising bond yields will free up companies to contribute less to pension plans, which are helped most by the rise in yields of U.S. Treasury debt with a long maturity. Last year"s "flattening" in the yield curve, in which long-dated yields fell faster than short-term yields, had hurt some pension plans.

Last week, U.S. defense company Lockheed Martin reported that its pension fund for employees nearly tripled its return on assets in 2017 from the year prior, but the plan"s funded status decreased over that same period from 69.7 percent to 68 percent. Also last week, $62.7 billion snack conglomerate Mondelez International reported that its pension plan, which was overfunded in 2016 at 100.4 percent, was in 2017 down to 97.4 percent. Greif, an industrial packaging firm, said the funded status for its U.S. pensions declined from 70.7 percent to 69.3 percent.

All told, it"s not just the swift rise in bond yields that is projected to help corporate pension funds.

Spurred by President Donald Trump"s tax overhaul, corporate pension plan sponsors across the United States upped their contributions hoping to take advantage of the old 35 percent tax rate, which is deductible from a tax bill, before they are forced to use the 21 percent rate in September.

United Parcel Service increased its pension contribution by $7.3 billion in 2017 over an expected $2.3 billion at the start of the year. General Motors, which manages the largest corporate pension plan in the United States, contributed $3 billion last year.

In 2017, Boeing added $3.5 billion, Delta added $3.2 billion, and Verizon added $3.4 billion in addition to the $600 million it had already pledged. Lockheed Martin plans to add $5 billion in 2018.

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