While the U.S. government keeps kicking its pension can down the road, corporate America is getting its house in order.
At the end of 2018, pension underfunding among S&P 500 companies came in at roughly $270 billion, down from an all-time high $451 billion in 2012, according to S&P Dow Jones Indices data. That was helped by a 96.3% advance in the S&P 500 index between 2012 and 2018, and a shift away from final salary pension, or defined benefit, schemes to defined contribution schemes, such as the 401(k).
"For private companies, the long-term reality is that, thanks to shrinking (and frozen) programs and fewer employees who are covered (fewer are added, as longevity reduces the covered ones), the end of onerous retirement obligations is on the horizon, although their full demise may be decades away," said Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.
This has also been achieved even as interest rates declined, pushing up liabilities. Despite bond yields rising in 2018, interest rates utilized for discounted pension liabilities were nearly half of those used in the 1999-2001 period, when pensions were overfunded, according to Silverblatt. Expected return rates on pension funds dropped for an 18th straight year, he said.
More fixed income, fewer stocks
Pension funds may have played the markets smartly too. Despite benefiting from rising stocks in recent years, they are well-positioned for a potential downturn, having reduced equities as a share of pension asset allocation to 33.04% in 2018 from 48.62% in 2012, SDJI data show. Fixed income assets made up 49.91% weighted of S&P 500 pension plans in 2018, compared to 40.36% in 2012.
U.S. companies aren't completely out of the woods yet though. A recession would hurt their pension funds' remaining equity holdings, while gains from rallying government bonds would be wiped out by rising liabilities.
"There's a fair amount of what I'll call asset-liability mismatch and risk associated with markets and market downturns," Scott Kaplan, senior vice president and head of pension risk transfer at Prudential Financial Inc., said in an interview. "To the extent that you're mismatched to begin with and interest rates fall, your liabilities rise, but your assets don't rise to the same extent."
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Fixing the roof
S&P 500 companies may also have squandered the opportunity to pay into their funds while times were good.
Companies that comprise the S&P 500 Industrials reported $1.392 trillion in cash and equivalents at the end of 2018, even as corporate pension underfunding still stood at $270 billion, according to an August report from S&P Dow Jones Indices.
Replenishing pension funds typically is not the first thing companies will do during an upturn, said Howard Silverblatt.
"The incentives are not there as much. When the [2017 tax cuts] came into effect, there was a boost to some payments because of the ability to deduct at a higher percentage," he said in an interview. "Companies typically don't add that much more into their pensions in good years."
The reduction of the U.S. corporate tax rate from 35% to 21% effective at the start of 2018 was an incentive for some companies to voluntarily fund their pension plans.
Still, corporations are doing much better than the public sector at managing their pension obligations.
States reported a $1.28 trillion funding gap in 2017, up from $934 billion in 2014, according to research from The Pew Charitable Trusts published in June, with just eight states being at least 90% funded and 24 states being below 70% funded.
Verizon, AT&T
Even those companies with the biggest underfunded pension and other post-employment benefits, or OPEB, liabilities do not have too much to worry about in that regard.
While Verizon Communications Inc.'s OPEB was underfunded by $15.2 billion in 2018 and AT&T Inc.'s was underfunded by $15.1 billion, their respective EBITDAs last year were $48.715 billion, and $56.264 billion, according to S&P Capital IQ data, suggesting they could plug the gaps relatively quickly if needed.
Those two telecommunications firms, along with Exxon Mobil, General Motors and Ford, are the top five S&P 500 companies with underfunded OPEB programs, making up 36.8% of the S&P 500's underfunding.
"There's been a big effort to de-risk pension plans and liabilities," said Carla Norfleet Taylor, a senior director in Fitch Ratings' corporate finance group. "The companies we looked at have been very proactive at doing that through the step up in contributions, possibly through the asset allocation shift towards fixed income to do more asset liability matching."

