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Facing down a bad year

How seriously will the stock market weakness affect US pension funds’ assets? Trustees, actuaries and advisers are trying to figure this out. After such a long period of fat returns, 2000 is the first year US defined benefit (DB) plans have missed their annual investment goals, usually ranging from 7–9.5%. That’s not surprising, giving that they invest an average of 60% of their assets in domestic equities and the Standard & Poor’s 500 index was down 9.09% over the year at December 31.
But things could be even worse if you take into account also the growth of their liabilities, according to an analysis by Ryan Labs, a New York- based research and consulting company. It was not only US pension funds’ assets that had negative growth for 2000: an average –2.5%, based on traditional weights of their asset allocations (60% in domestic equities, 5% in international equities, 30% in bonds, and 5% in cash) and on performance of these assets (–9.09% S&P500, –13.87% MS EAFE, +11.63% Lehman index, +6.31% three-month Treasury Bill).
In addition, liabilities grew an average 25.96%, based on the Ryan Labs Liability Index, the first in the US. “Liabilities are to be priced as a high quality zero-coupon bond portfolio, where each liability is priced at market interest rates. That means liabilities have total return growth behaviour, ” says Ryan Labs, which goes on to ask: “If a five-year average duration index (Lehman) grew at 11.63 % in 2000, wouldn’t a longer bond portfolio grow more?” The Liability Index created by Ryan Labs has an average duration of 15.5 years, a proxy for the average pension plan. Its growth in 2000 was an astonishing 25.96%, due to interest rates being lowered.
Liability growth plus asset growth, means the average pension fund lost 28.46% last year. Ryan Labs concludes: “Asset/liability ratios will now be radically adjusted. Surplus mined pensions may now find themselves in a deficit position if surplus was less than 28%.”
Other bad years – according to Ryan Labs – were 1989, 1992, 1993 and 1995, but 2000 results were the worst since 1987 and could force some plans to start asking for contributions, after a long period of “contribution holidays”. For the first time in many years, many private corporations could see earnings cut because of pension expenses, while they used to profit from pensions’ overfunding.
The first big company reporting this kind of problem was aerospace group Northrop Grumman Corp, which said recently that its 2001 earnings (estimated by analysts at $9.15 a share) could drop by 45 cents a share, because of its pension plan’s declining assets.
Many smaller pension funds are likely to face bigger troubles: they could have to increase their contribution levels, if they find themselves below break-even levels.
Not all consultants agree that the situation is so bad. Frank Russell, for example, declared to the Dow Jones Newswires that its average client had a 30% surplus in his fund at the end of 1999 and that pension funds’ liabilities shrank last year, due to many changes in the plans. So their financial positions actually improved and they are still in a very well-funded situation.
Actuaries at William M Mercer Investment Consulting point out that many companies use spreading techniques to amortise the impact of declining pension assets over a period of years.
On the other hand, most large pension funds look like they are not worried about the current stock market weakness and will stick to their long-term investment strategies. The New York State Teachers’ Retirement System ($80bn (e85bn) assets), for example, which invests 60% of its assets in domestic stocks, sits confidently on a 16.5% annual return earned in the last five years or 13.7% annual return for the past 10 years. So, even if the results don’t meet its annual actuarial target of 8%, the fund’s managers claim they are not concerned.
A similar feeling comes from other pension plans, like the Sacramento pension fund ($100bn assets), which earned 13.4%in the 12 months ended June 1999 or the Florida state fund ($95bn), which had a return of 8.84% for the 12 months ended October 1999.

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