Based on the study conducted by analysts at Bank of America Merrill Lynch, the S&P 500 pension fund deficit will increase to nearly $429 billion this year, the highest funding deficit since 1996. In 2011, the pension funding deficit was $371 billion.
The analysts based their estimate on the assumption that the discount rate would drop by 3.9 percent in 2012, from 4.7 percent in 2011, and 9.5 percent actual return on plan assets. According to them, better asset returns and contributions are not enough to offset a lower discount rate.
The research firm estimated that the pension funding ratio will decline from 78.4 percent in 2011 to 77.5 percent, its lowest since 2008. According to the analysts, only 7.2 percent or 25 out of 345 companies in the S&P 500 will have a fully funded pension plans this year. Thirty four percent (34%) or 118 companies will have their pension plans funded by 70 to 80%.
In 2011, only 4 out of 126 state pension funds were fully funded.
Additionally, pension benefits will take a hit on earnings. The analysts write, “Based on our projection for a higher pension benefit obligation (PBO) at the end of 2012 and the amortization of unrecognized losses, we see a ($0.75) pension impact on 2013 S&P 500 EPS. This would be about a 70 bps drag on growth from 2012 and is another reason our US Equity Strategy team is comfortable with their below consensus EPS estimate for the S&P 500 of $110."
The analysts explained that the weak performance of equity markets over the past decade contributed to the pension deficit, but the main factor was the decreasing interest rate. According to them, “In pension accounting, a falling discount rate will make the pension benefit obligation (PBO) increase, which can lead to a widening funding deficit if the return on pension assets does not keep pace.”
The research firm said it is practical for pension managers to reallocate some of their fixed income to equities. BAML credit strategist, Hans Mikkelsen, believed that 2013 is the year of transition from three decades of a bull market in bonds to a period of rising interest rates and equities.
In related news, the California Public Employees’ Retirement System (Calpers), the largest pension fund in the United States, reported 13 percent income on invested assets last year, due to increases in stocks and private equity.
According to Calpers, its investments in private equity increased by 12 percent as of September 2012, and the returns from its publicly traded shares rose by 17 percent. During the financial crisis in 2008, the pension fund lost around 28 percent of its investments.