With the global economy taking its toll on stocks and bonds, pension funds are coming up short.
Lesser returns on stocks and low bond yields translate into the need for greater contributions by publicly traded companies and governments to keep pensions fully funded. And increased contributions mean more stress on earnings, cash flow and already strapped budgets.
“When the market goes up, it has the impact of increasing the attractiveness of the stock. It can magnify the direction of the stock and the market overall,” said Tom Mangan, senior vice president and portfolio manager of Beavercreek-based James Investment Research Inc. “It makes things really, really bad when things are bad and really, really good when the markets are good.”
For example, in mid-August, Credit Suisse analyst David Zion estimated the pension plans of AK Steel , Supervalu , Lockheed Martin and Northrop Grumman , all of which have Dayton area operations, had declined equal to or more than 10 percent of the companies’ market value.
According to Zion, there’s a $388 billion gap in corporate pension plans of S&P 500 companies, which is even higher than the $326 billion funding gap recorded in 2008. AK Steel has a $1.3 billion funding gap in its pension, which represents 92.4 percent of the company’s market capitalization. And Lockheed Martin has a $14.3 billion funding gap, which represents 38.8 percent of the company’s market cap.
Mangan said part of the problem pensions face is they are set up based on expected returns from the more robust stock market days and don’t account for the years of compound negative returns the country experienced.
For that reason, a number of companies with the means to make a switch have started to provide defined contributions rather than defined benefits, Mangan said.
A defined contribution plan is a retirement plan in which a set amount is contributed to the plan each year. These plans, the most common of which is a 401(k) plan, don’t have an expected retirement benefit.
A defined benefit plan, on the other hand, is a retirement plan with specifiec retirement benefits. The annual contribution to the plan then is based on what is necessary to meet those set benefits and is not determined by profits.
However, a number of companies don’t have the option to switch to defined contributions because of bargaining agreements already in place.