Pension Review “First Take:” Highlights, Challenges and Changes …online.wsj.com/public/resources/documents/pensionreview.pdf · 2018-08-27 · Pension Review “First Take:”

Pension Review “First Take:” Highlights, Challenges and Changes for 2012

White Paper April 2012

gsam.com

This material has been prepared by GSAM and is NOT a product of Goldman Sachs Global Investment Research. The views and opinions expressed may differ from those of Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures. This material is provided for information purposes only and does not constitute a solicitation or offer to provide any advice or services in any jurisdiction in which such a solicitation or offer is unlawful or to any person to whom it is unlawful. Please note that Goldman Sachs Asset Management does not maintain any licenses, authorizations or registrations in Asia ex Japan, except that it conducts businesses (subject to applicable local regulations) in and from the following jurisdictions: Hong Kong, Singapore, Malaysia, Korea, and India.

Executive SummaryCorporate defined benefit (DB) pension plans are facing challenges from multiple angles. While funded levels have begun to recover in early 2012 given the rise in equity markets and long-term interest rates, they started the year at depths as low as those seen in late 2008 during the height of the financial crisis. Low funded levels are pressuring some plan sponsors from a balance sheet, income statement and cash flow perspective, increasing the attention paid to pension issues from investors, bond holders, rating agencies and, of course, plan sponsors themselves.

In response, some sponsors are proactively changing plan design, contribution policies and financial reporting, while fiduciaries are reconsidering investment strategy and asset allocation. Other regulatory and accounting changes may be thrust upon the pension landscape.

Our “First Take” review of some of the recently filed pension information for 50 companies with some of the largest DB plans in the United States confirms many of these challenges and changes. Based upon this review, as well as our conversations with plan sponsors, we highlight seven themes that we believe will be prevalent throughout the US corporate pension community during 2012:

I. The long-term trend of de-risking and Liability-Driven Investing (LDI) remains in place for many corporate DB plans

II. The definitions of “success” in terms of plan performance continue to evolve

III. Return assumptions should remain under pressure, leading to multiple ramifications for plan sponsors

IV. Contribution activity will be robust in 2012 and beyond

V. More corporate sponsors are likely to contemplate financial reporting changes given pension deficits and large unrecognized losses

VI. Potential regulatory and accounting changes will contribute to uncertainty for plan sponsors

VII. Pensions will remain the focus, but retiree health care will continue to gain attention as a growing issue in the retirement space

Michael A. Moran, CFAPension StrategistGoldman Sachs Asset Management (GSAM)

2 | Goldman Sachs Asset Management


This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.

A Look at Funded Status and the ImplicationsPlan sponsors no doubt have seen markets recover and deliver strong returns for risk assets in 2012. But plans are still facing significant challenges, starting with funded status. The aggregate funded status of US plans of S&P 500 companies ended 2011 at around 80%, down from 85% at the end of 2010 (see Exhibit 1). Our preliminary estimate of 2011 funded status is based on our 50-company sample of companies with some of the largest corporate pension plans in the United States. These companies account for about one-third of all corporate DB pension assets in the United States, thereby providing a reasonable picture of the overall US corporate pension universe.

Exhibit 1: Funded status has started to recover given rise in equity markets and interest ratesS&P 500 US plans; 2011 preliminary results based on our 50-company “First Take” sample

Source: Goldman Sachs Asset Management; company reports.

We note that historically larger plans have tended to maintain higher funded ratios than smaller plans. Consequently, we suspect that when we have compiled the funded levels for all plans in the S&P 500, consistent with the historical series displayed in Exhibit 1, the final aggregate funded level for 2011 would be somewhat lower than the 80% indicated in the chart. While these ratios are based on the aggregate levels of plan assets and liabilities for corporate plans, the median plan funded level is usually several percentage points below the aggregate amount. In other words, the median US corporate plan was likely funded around 75% at the end of 2011.

While asset returns were, in some cases, disappointing in 2011, it was the liability side of the equation that has hurt corporate funded status more. Many calendar year-end plan sponsors have announced that their accounting discount rates declined by 50 to 100 basis points at the end of 2011, commensurate with the decline in several popular high quality long-term interest rate benchmarks such as the Moody’s Aa Corporate Bond Index. These declines have increased the present value of plan-specific pension obligations anywhere from 5% to 15% depending on the duration of the liabilities. These increases are, of course, in addition to the increases to the liability from new benefit accruals during the year as well as the interest accretion on the level of the liability at the beginning of the year.

This decline in funded levels has multiple ramifications for plan sponsors. Balance sheets of the plan sponsor immediately reflect the decline in funded status at the end of the firm’s fiscal year. This, for most sponsors, resulted in the recognition of a larger pension liability and a reduction in stockholders equity at year-end 2011.

GA

AP

Fun

ded

(%)

2002 2003 2004 2005 2006 2007 2008 2009 2011(P)2010 2012(E)YTD

70

80

90

100

110

84%

90%92% 93%

101%

108%

79%

82%80%

83%85%

Goldman Sachs Asset Management | 3



The amount of expense recognized by plan sponsors will rise in 2012 and beyond as “losses” from the rise in the pension obligation due to lower interest rates or actual plan asset returns that fell below expected return on asset assumptions are reflected through the income statement. Due to the mechanics of these calculations, many plan sponsors will see recognized pension expense continue to rise beyond 2012 even if pension funded levels rise this year. Much of this is due to the many smoothing mechanisms embedded in pension expense recognition as driven by existing accounting standards.

As seen in Exhibit 2, the aggregate amount of pension expense recognized by S&P 500 companies on their US plans rose every year from 2003 to 2006, despite the fact that funded status was improving at the same time. The challenging market environment for many pension plans over the past few years will create a similar dynamic in which growing losses related to plan assets and liabilities need to be recognized through the income statement. The exception to this will be those plans that have changed their financial reporting recently to more of a mark-to-market type of system, a topic we address later in this report.

Exhibit 2: Elevated pension expense has garnered attention in recent yearsS&P 500 US plans


Finally, the decline in funded levels will contribute to an increase in contributions for some sponsors. For some plans this will not just be a 2012 issue, but rather one that will stretch on for several years.

While public DB plans do not value their liabilities based on market interest rates, and therefore have not seen these obligations grow due to declining discount rates like their corporate sector counterparts, they have also been impacted by, in some cases, disappointing asset returns. Exhibit 3 compares the aggregate reported funded level of corporate plans and public plans based on “as reported” figures. Since many public plans smooth the value of their assets for reported funded status purposes, the downward trend in public sector funded levels seen in the chart may continue into the foreseeable future, even if equity markets continue to rise during 2012.

S&

P 5

00 P

ensi

on E

xpen

se/(I

ncom

e)

(in $

Bill

ions

)

2002

-$0.8

$22.3$25.8

$28.4

$37.4

After the 2000-2002 downturn, pension expense did not peak until 2006.

$22.9

$16.7

$32.4 $32.0

2003 2004 2005 2006 2007 2008 2009 2010

-5

0

5

10

15

20

25

30

35

40

Pension expense will likely continue to stay at elevated levels in future years.




Exhibit 3: Reported public plan funded ratios may continue to fall for several yearsData “as reported” by corporate and public plans

Source: Goldman Sachs Asset Management; company reports; National Association of State Retirement Administrators.

GSAM’s “First Take” on Corporate DB Pension PlansEach year, we perform a comprehensive review of the DB pension and retiree health care plans of every company in the S&P 500 based on the information in their 10-Ks filed with the Securities and Exchange Commission (SEC). This review includes such items as plan expense, funded status, asset allocation, plan contributions, and actuarial assumptions. The robust and consistent data set of pension information derived from this review allows us to perform detailed analysis on a broad range of pension-related issues.

Compiling, scrubbing, and analyzing the data for every company in the S&P 500 is a time-consuming exercise. Consequently, as we have done in previous years, we have performed an initial review on 50 of the companies in the S&P 500 with the largest US DB plans in order to provide our clients with initial impressions on the status and direction of these plans. We will follow up later this spring with our complete review for all companies in the S&P 500.

The data for the 50 companies in this initial review are detailed in Exhibits 4 and 5. This data provides the basis for our “First Take” on 2011 results and also helps to enlighten our analysis of key trends and themes we expect to see play out over the upcoming year. Information in this initial review includes funded levels, actual and target asset allocations, and key actuarial assumptions.

For example, note in Exhibit 4 that the aggregate funded level for this 50 company sample declined from 86% in 2010 to 80% in 2011, corresponding to the preliminary figures in Exhibit 1. The target and actual asset allocation figures in Exhibit 5 shed light on not only current investment strategy policies, but a comparison of these figures to prior disclosures helps to clarify how strategies have evolved over time. The same is true for information on actuarial assumptions, such as the expected return on plan assets, and allocations to relatively illiquid securities, such as those designated “Level 3.” Information on these metrics are also included in Exhibit 5.

For the remainder of the report, we outline seven themes that we believe will be prevalent during 2012.

Agg

rega

te F

unde

d R

atio

(%)

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011(E)

70

80

90

100

110S&P 500 US PlansPublic Plans



2010

Ticker Company Name Industry

Pension Expense/

(Income) $ Obligation $ Assets $

GAAP Funded Status $

GAAP Funded %

IBM Intl. Bus. Machines Corp. IT Consulting and Other Svcs. (935) 51,293 50,259 (1,034) 98%BA Boeing Co. Aerospace and Defense 1,367 59,106 49,252 (9,854) 83%T AT&T, Inc. Integrated Telec. Services 2,536 56,187 47,621 (8,566) 85%GE General Electric Co. Industrial Conglomerates 1,072 51,999 44,801 (7,198) 86%F Ford Motor Co. Automobile Manufacturers 122 46,647 39,960 (6,687) 86%VZ Verizon Communications Inc. Integrated Telec. Services (83) 29,217 25,814 (3,403) 88%LMT Lockheed Martin Corporation Aerospace and Defense 1,442 35,773 25,345 (10,428) 71%NOC Northrop Grumman Corp. Aerospace and Defense 595 25,263 23,265 (1,998) 92%UTX United Technologies Corp. Aerospace and Defense 218 24,445 22,384 (2,061) 92%UPS United Parcel Service, Inc. Air Freight and Logistics 573 21,342 20,092 (1,250) 94%DD EI DuPont de Nemours & Co. Diversified Chemicals 557 23,924 18,403 (5,521) 77%BAC Bank of America Corporation Other Div. Financial Svcs. 302 17,016 18,337 1,321 108%DOW The Dow Chemical Company Diversified Chemicals 502 21,158 15,851 (5,307) 75%RTN Raytheon Co. Aerospace and Defense 894 18,407 14,502 (3,905) 79%JNJ Johnson & Johnson Pharmaceuticals 583 14,993 13,433 (1,560) 90%FDX FedEx Corporation Air Freight and Logistics 308 13,983 13,055 (928) 93%HON Honeywell International Inc. Aerospace and Defense 301 14,990 12,181 (2,809) 81%MMM 3M Co. Industrial Conglomerates 144 12,319 11,575 (744) 94%C Citigroup, Inc. Other Div. Financial Svcs. (129) 12,388 11,561 (827) 93%XOM Exxon Mobil Corporation Integrated Oil and Gas 1,388 15,007 10,835 (4,172) 72%JPM JPMorgan Chase & Co. Other Div. Financial Svcs. 138 8,320 10,828 2,508 130%CAT Caterpillar Inc. Const., Farm Mach. and Trucks 527 13,024 10,760 (2,264) 83%PFE Pfizer Inc. Pharmaceuticals 590 14,436 10,596 (3,840) 73%PRU Prudential Financial, Inc. Life and Health Insurance (32) 9,198 10,533 1,335 115%PCG PG & E Corp. Multi-Utilities 164 12,071 10,250 (1,821) 85%WFC Wells Fargo & Company Diversified Banks (10) 11,030 9,639 (1,391) 87%DE Deere & Company Const., Farm Mach. and Trucks 104 10,197 9,504 (693) 93%AA Alcoa, Inc. Aluminum 233 12,343 9,451 (2,892) 77%HPQ Hewlett-Packard Company Computer Hardware (49) 10,902 9,427 (1,475) 86%PEP Pepsico, Inc. Soft Drinks 291 9,851 8,870 (981) 90%EXC Exelon Corp. Electric Utilities 324 12,524 8,859 (3,665) 71%X United States Steel Corp. Steel 217 10,630 8,655 (1,975) 81%CVX Chevron Corp. Integrated Oil and Gas 595 10,271 8,579 (1,692) 84%IP International Paper Co. Paper Products 231 9,824 8,344 (1,480) 85%BRK.A Berkshire Hathaway Inc. Property and Casualty Ins. 249 10,598 8,246 (2,352) 78%ED Consolidated Edison Inc. Multi-Utilities 453 10,307 7,721 (2,586) 75%ABT Abbott Laboratories Pharmaceuticals 278 8,606 7,451 (1,155) 87%MRK Merck & Co. Inc. Pharmaceuticals 317 8,400 7,200 (1,200) 86%LLY Eli Lilly & Co. Pharmaceuticals 184 8,115 6,983 (1,132) 86%SO Southern Company Electric Utilities 54 7,223 6,834 (389) 95%MET MetLife, Inc. Life and Health Insurance 324 7,043 6,310 (733) 90%GD General Dynamics Corp. Aerospace and Defense 166 9,238 6,250 (2,988) 68%KFT Kraft Foods Inc. Packaged Foods and Meats 322 6,703 5,800 (903) 87%BMY Bristol-Myers Squibb Co. Pharmaceuticals 60 6,704 5,766 (938) 86%DIS Walt Disney Co. Movies and Entertainment 412 8,084 5,684 (2,400) 70%AET Aetna Inc. Managed Healthcare 164 5,821 5,244 (577) 90%MO Altria Group Inc. Tobacco 154 6,439 5,218 (1,221) 81%D Dominion Resources, Inc. Multi-Utilities 20 4,490 5,106 616 114%RAI Reynolds American Inc. Tobacco 12 5,529 4,934 (595) 89%DUK Duke Energy Corporation Electric Utilities 51 5,028 4,797 (231) 95%

Totals for sample $18,301 $838,406 $722,365 ($116,041) 86%Source: Goldman Sachs Asset Management; company reports.


Exhibit 4: Summary of funded status and expense for large US plans in 2011 compared to 2010 (continued on next page)S&P 500 US plans; $ amounts in millions; sorted by 2010 plan assets



2011Funded Status Year-Over-Year

Ticker Company Name

Pension Expense/

(Income) $ Obligation $ Assets $

GAAPFunded Status $

GAAP Funded % $ Change % Change

IBM Intl. Bus. Machines Corp. (759) 54,085 51,218 (2,867) 95% (1,833) -3%BA Boeing Co. 2,279 67,651 51,051 (16,600) 75% (6,746) -8%T AT&T, Inc. 5,160 58,404 45,907 (12,497) 79% (3,931) -6%GE General Electric Co. 2,446 60,510 42,137 (18,373) 70% (11,175) -17%F Ford Motor Co. 351 48,816 39,414 (9,402) 81% (2,715) -5%VZ Verizon Communications Inc. 4,139 30,582 24,110 (6,472) 79% (3,069) -10%LMT Lockheed Martin Corporation 1,821 40,616 27,292 (13,324) 67% (2,896) -4%NOC Northrop Grumman Corp. 238 24,129 21,340 (2,789) 88% (791) -4%UTX United Technologies Corp. 359 27,167 23,542 (3,625) 87% (1,564) -5%UPS United Parcel Service, Inc. 1,251 24,386 22,663 (1,723) 93% (473) -1%DD EI DuPont de Nemours & Co. 656 27,083 17,794 (9,289) 66% (3,768) -11%BAC Bank of America Corporation 302 18,028 18,131 103 101% (1,218) -7%DOW The Dow Chemical Company 565 22,763 16,119 (6,644) 71% (1,337) -4%RTN Raytheon Co. 1,060 20,905 14,931 (5,974) 71% (2,069) -7%JNJ Johnson & Johnson 781 17,424 13,736 (3,688) 79% (2,128) -11%FDX FedEx Corporation 543 16,784 15,518 (1,266) 92% (338) -1%HON Honeywell International Inc. 1,580 15,600 12,836 (2,764) 82% 45 1%MMM 3M Co. 251 14,499 12,102 (2,397) 83% (1,653) -10%C Citigroup, Inc. (160) 13,090 11,991 (1,099) 92% (272) -2%XOM Exxon Mobil Corporation 1,349 17,035 10,656 (6,379) 63% (2,207) -10%JPM JPMorgan Chase & Co. 31 9,043 10,472 1,429 116% (1,079) -14%CAT Caterpillar Inc. 482 14,782 9,997 (4,785) 68% (2,521) -15%PFE Pfizer Inc. 492 16,266 12,005 (4,261) 74% (421) 0%PRU Prudential Financial, Inc. 48 11,113 11,812 699 106% (636) -8%PCG PG & E Corp. 256 14,000 10,993 (3,007) 79% (1,186) -6%WFC Wells Fargo & Company (106) 11,325 9,061 (2,264) 80% (873) -7%DE Deere & Company 91 10,925 9,552 (1,373) 87% (680) -6%AA Alcoa, Inc. 296 13,526 10,311 (3,215) 76% (323) 0%HPQ Hewlett-Packard Company (113) 11,945 10,662 (1,283) 89% 192 3%PEP Pepsico, Inc. 352 11,901 9,072 (2,829) 76% (1,848) -14%EXC Exelon Corp. 267 13,538 11,302 (2,236) 83% 1,429 13%X United States Steel Corp. 372 10,770 8,353 (2,417) 78% (442) -4%CVX Chevron Corp. 526 12,165 8,720 (3,445) 72% (1,753) -12%IP International Paper Co. 195 10,555 8,185 (2,370) 78% (890) -7%BRK.A Berkshire Hathaway Inc. 282 12,992 9,150 (3,842) 70% (1,490) -7%ED Consolidated Edison Inc. 554 11,825 7,800 (4,025) 66% (1,439) -9%ABT Abbott Laboratories 377 8,963 6,961 (2,002) 78% (847) -9%MRK Merck & Co. Inc. 309 8,700 6,800 (1,900) 78% (700) -8%LLY Eli Lilly & Co. 207 9,191 7,186 (2,005) 78% (873) -8%SO Southern Company 19 8,079 6,800 (1,279) 84% (890) -10%MET MetLife, Inc. 341 8,327 7,108 (1,219) 85% (486) -4%GD General Dynamics Corp. 293 10,242 6,250 (3,992) 61% (1,004) -7%KFT Kraft Foods Inc. 351 7,472 5,829 (1,643) 78% (740) -9%BMY Bristol-Myers Squibb Co. 27 7,499 5,842 (1,657) 78% (719) -8%DIS Walt Disney Co. 508 9,481 6,551 (2,930) 69% (530) -1%AET Aetna Inc. (15) 6,130 5,297 (834) 86% (257) -4%MO Altria Group Inc. 188 6,965 5,275 (1,690) 76% (469) -5%D Dominion Resources, Inc. 25 4,981 5,145 164 103% (452) -10%RAI Reynolds American Inc. 67 5,766 5,110 (656) 89% (61) -1%DUK Duke Energy Corporation 56 5,040 4,741 (299) 94% (68) -1%

Totals for sample $30,990 $923,065 $734,830 $(188,234) 80% $(72,193) -7%



Exhibit 4: Summary of funded status and expense for large US plans in 2011 compared to 2010 (continued from previous page)S&P 500 US plans; $ amounts in millions; sorted by 2010 plan assets



Target Asset Allocation % Actual Asset Allocation-2011 %

Company Name Equity DebtReal

Estate Other Equity DebtReal

Estate Other Total

Level 3 assets

as a % of total plan

assets

Expected Return on Plan Assets (2011)

Discount Rate (as of

year-end 2011)

Unrecognized (Gains/ Losses)

Intl. Bus. Machines Corp. 43 46 6 5 31 48 5 16 100 15.5% 8.00% 4.20% 18,561 Boeing Co. 30 49 6 15 26 53 6 15 100 15.2% 7.75% 4.40% 24,448 AT&T, Inc. 35-55 30-40 6-16 4-19 39 34 11 16 100 26.1% 8.25% 5.30% 0 General Electric Co. 34-74 10-40 4-14 6-29 45 27 8 20 100 28.4% 8.00% 4.21% 26,923 Ford Motor Co. 0 80 0 20 34 56 1 9 100 14.5% 8.00% 4.64% 9,394 Verizon Communications Inc. 25 30 8 37 28 23 9 40 100 37.6% 8.00% 5.00% 0 Lockheed Martin Corporation 10-55 10-60 0-10 0-50 34 40 1 25 100 12.2% 8.50% 4.75% 15,698 Northrop Grumman Corp. 15-55 30-50 15-30 15-30 31 46 8 15 100 24.0% 8.50% 5.03% 6,131 United Technologies Corp. 65 35 0 0 43 34 6 17 100 12.2% 7.90% 4.70% 9,436 United Parcel Service, Inc. 40-60 20-40 1-10 6-31 41 36 5 18 100 22.4% 8.75% 5.64% 2,439 EI DuPont de Nemours & Co. 47 29 8 16 39 25 7 29 100 25.3% 9.00% 4.49% 12,477 Bank of America Corporation 60-80 20-40 0-5 0-10 47 40 2 11 100 3.7% 8.00% 4.95% 7,152 The Dow Chemical Company 40 40 0 20 38 37 7 18 100 15.4% 8.18% 4.98% 8,335 Raytheon Co. 35-70 25-40 0 3-35 46 28 1 25 100 5.0% 8.68% 5.00% 10,626 Johnson & Johnson 75 25 0 0 74 26 0 0 100 1.1% 9.00% 5.22% 6,030 FedEx Corporation 45 49 0 6 50 44 0 6 100 2.6% 8.00% 5.76% 5,386 Honeywell International Inc. 60-70 10-20 5-15 10-20 55 29 6 10 100 16.1% 8.00% 4.89% 1,559 3M Co. 37 26 0 37 28 33 0 39 100 26.5% 8.50% 4.15% 5,623 Citigroup, Inc. 0-34 30-67 0-7 8-44 16 44 5 35 100 32.5% 7.50% 4.70% 4,440Exxon Mobil Corporation 50 50 0 0 46 49 0 5 100 4.3% 7.50% 5.00% 6,475 JPMorgan Chase & Co. 25-60 10-30 5-20 15-50 39 20 5 36 100 33.8% 7.50% 4.60% 3,669 Caterpillar Inc. 70 30 0 0 68 28 0 4 100 1.4% 8.50% 4.30% 7,044 Pfizer Inc. 25-50 30-55 10-15 10-15 36 30 0 34 100 13.2% 8.50% 5.10% 5,204 Prudential Financial, Inc. 5-28 58-74 1-8 0-25 10 73 4 13 100 14.8% 7.00% 4.85% 1,549 PG & E Corp. 35 50 5 10 38 55 0 7 100 10.3% 6.60% 4.66% 213 Wells Fargo & Company 35-55 35-55 0-10 0-10 45 42 5 8 100 8.7% 8.25% 5.00% 2,836 Deere & Company 37 39 5 19 37 32 5 26 100 17.6% 8.10% 4.40% 4,473 Alcoa, Inc. 20-55 30-65 0 5-25 34 50 0 16 100 26.7% 8.50% 4.90% 5,191 Hewlett-Packard Company 40 60 0 0 23 63 0 14 100 12.8% 8.00% 4.80% 1,020 Pepsico, Inc. 55 40 5 0 58 40 0 2 100 0.3% 7.80% 4.60% 4,217 Exelon Corp. 30-40 35-55 0 20-30 32 47 0 21 100 21.7% 8.00% 4.74% 4,311 United States Steel Corp. 60 40 0 0 54 27 3 16 100 10.2% 8.00% 4.50% 4,589 Chevron Corp. 40-70 20-65 0-15 0-5 61 25 10 4 100 10.3% 7.80% 3.80% 5,982 International Paper Co. 40-51 30-40 7-13 9-18 43 34 11 12 100 28.8% 8.25% 5.10% 4,453 Berkshire Hathaway Inc. na. na. na. na. 40 23 0 37 100 4.3% 6.90% 4.60% 2,521 Consolidated Edison Inc. 55-65 27-33 8-12 0 61 32 7 0 100 8.7% 8.50% 4.70% 5,351 Abbott Laboratories na. na. na. na. 45 27 0 28 100 9.1% 7.80% 5.00% 3,822 Merck & Co. Inc. 65-90 15-25 0 0-8 63 27 1 9 100 5.1% 8.70% 4.80% 2,793 Eli Lilly & Co. 0-81 19 0 0-81 27 17 6 50 100 31.4% 8.50% 5.00% 4,858 Southern Company 51 23 14 12 54 23 14 9 100 20.3% 8.45% 4.98% 102 MetLife, Inc. 0-40 50-80 0 10-20 24 53 0 23 100 11.0% 7.25% 4.95% 2,498 General Dynamics Corp. 25-75 10-50 0 0-20 64 34 0 2 100 2.0% 8.37% 5.22% 4,790 Kraft Foods Inc. 70 30 0 0 66 33 1 0 100 10.5% 7.95% 4.85% naBristol-Myers Squibb Co. 70 22 0 8 57 31 0 12 100 9.2% 8.75% 4.40% 4,297 Walt Disney Co. 36-60 20-40 0-15 15-30 41 35 4 20 100 17.9% 7.75% 4.75% 3,749 Aetna Inc. 43-53 37-43 10-14 10-14 50 37 9 4 100 13.0% 7.50% 4.98% 2,735 Altria Group Inc. 55 45 0 0 52 43 0 5 100 0.2% 8.00% 5.00% 2,788 Dominion Resources, Inc. 46 33 3 18 40 33 6 21 100 25.0% 8.50% 5.50% 2,211 Reynolds American Inc. 29 56 4 11 30 58 4 8 100 10.3% 7.75% 5.00% 570 Duke Energy Corporation 53 32 4 11 52 32 9 7 100 6.7% 8.25% 5.10% 201 Equal-Weighted Average 46 37 4 13 43 37 4 16 100 14.7% 8.07% 4.81%Asset-Weighted Average 42 39 5 14 40 38 5 17 100Total $279,169

Exhibit 5: Target and actual asset allocations and selected pension-related dataS&P 500 US plans; $ amounts in millions; sorted by 2010 plan assets






Seven Themes for 2012

I. Long-term theme of de-risking and LDI remains in place for many corporate DB plansDespite the fall in funded levels for many DB plans last year, as well as persistently low long-term interest rates, we believe the long-term theme of de-risking and moving to LDI-type strategies remains in place for many plans. This can be seen in the commentary that many plans have made recently regarding investment strategy direction, such as Ford’s recent disclosure of increasing its long-term target allocation to fixed income to 80%, as well as in actual asset allocation changes that have been enacted by some sponsors.

Exhibit 6 details the asset-weighted actual asset allocations for US DB plans of S&P 500 companies since 2002. This simple chart highlights two of the most common trends in US corporate asset allocation over the past several years:

Increase in the liability-hedging portfolio (i.e, debt), and

Diversification of the return-generating portfolio through, among other moves, increases in alternative assets which are often classified as “other”.

Exhibit 6: Corporate DB asset allocation has shifted over timeS&P 500 US plans


While we see that these trends continued during 2011 based on the preliminary data that we compiled for our “First Take” analysis, we note that larger plans, such as those in this sample, have been more meaningful adopters of the two strategies detailed above. Consequently, when asset allocation information for all plans in the S&P 500 is complied it is likely, as we have seen in previous years, that the actual allocation to equities as of year-end 2011 will be somewhat higher than as reflected in the chart while allocations to debt and “other” would be somewhat lower.

While this long-term theme of de-risking is still evident, in the short-term, however, many plans may be hesitant to implement such strategies given recent declines in funded levels and historically low interest rates. Dynamic asset allocation strategies and glide paths, popular topics in the corporate pension world over the past few years, have called for pension plans to de-risk as funded status improves. This essentially involves shifting more assets into long duration fixed income, thereby better aligning the characteristics of plan assets with plan liabilities.

2002

84%

2003

90%

2004

92%

2005

93%

2006

101%

2007

108%

2008

79%

2010

85%

2011(P)

80%(P)

2009

82%

0

Funded

10

20

30

40

50

60

Stable allocation to equities took asharp step down in 2007 despite rising share prices at that time

Downward trend has continued as more plans have, over time, moved to LDI-type strategies

Targets at 2011

Year-End

70

Equity Debt Other Real Estate

42%39%

14%

5%

59

31

6

4

63

27

6

4

64

28

5

3

63

28

6

3

62

28

6

4

56

32

8

4

45

41

9

5

48

35

14

3

47

35

15

3

40

38

17

5Ass

et-W

eigh

ted

Act

ual A

sset

Allo

catio

ns (%

)






Exhibit 7 presents a framework for thinking about shifting risk based on the funded status of the plan. If the glide path calls for de-risking a pension plan when the plan’s funded status improves then, within limits, plan fiduciaries may want to consider a strategy of re-risking a pension plan when markets move adversely. Any such re-risking would be subject to an appropriate upper limit to risk taking, as determined by the plan fiduciaries. While some plans agree, in theory, with such a framework, many have been hesitant to effectuate such strategies.

Exhibit 7: Funded status plays a notable role in a dynamic strategy

Source: Goldman Sachs Asset Management. For illustrative purposes only.

Instead, a more popular conversation around glide paths and dynamic asset allocation strategies has revolved around potential supply/demand imbalances with respect to long duration fixed income. In other words, if funded levels improve through either rising interest rates or equity markets, then many corporate DB plans will be seeking to buy high quality long duration fixed income at the same time, potentially placing a ceiling on the long end of the curve.

Finally, we note that a change in the discount rate used to calculate lump sum distributions, which was included in the Pension Protection Act of 2006 (PPA), is fully phased in during 2012. This change links the value of the lump sum payment to high quality corporate bond rates. Previously the rate used was based on 30-year Treasury rates. This change makes lump sum payments more attractive for plan sponsors since a) corporate bond rates are higher than Treasury rates, so the value of the lump sum is lower than under previous regulations and b) the payment of the lump sum lowers the obligation by roughly the same amount. Implementing a lump sum option, for some plans, might be another way to de-risk the plan and shrink the gross pension obligation. We expect to see more plan sponsors offer lump sum options in 2012 as another de-risking strategy.

Plan Funded Status

Re-Risking

(When funded

status deteriorates)

De-Risking

(When funded

status improves)

Glide Path or

Journey Plan


1 This sample is slightly different to the 50 company sample in Exhibits 4 and 5. In order to make the comparison of actual returns “apples to apples,” we only used companies with December year-ends. Essentially the sample included all of the companies in the aforementioned exhibits that had December fiscal year-ends as well as some additional companies to bring our sample up to 50 in total. All of the plans in the sample had at least $4.5 billion of assets as of the end of 2011.

2 The ironic part of this analysis is that those plans that moved to more of an LDI-type strategy and had previously increased allocations to fixed income had some of the best performance during 2011. The purpose of this discussion is to think about how, on an ongoing basis, plan sponsors will need to evaluate and monitor plan performance.

Expected returns are estimates of hypothetical average returns of economic asset classes derived from statistical models. There can be no assurance that these returns can be achieved. Actual returns are likely to vary. Please see additional disclosures. These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary.This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.


II. Definitions of “success” in terms of plan performance continue to evolveHistorically, many plans evaluated themselves based on their plan asset returns versus returns for a peer group or against asset benchmarks such as the S&P 500 or the MSCI All Country World Index. But as more and more corporate plans have moved to LDI strategies, or are contemplating such a move, measuring performance and “success” becomes much different than in the past. If a plan’s focus has shifted to measuring asset performance against liability performance, then surplus volatility becomes a more relevant metric rather than purely asset returns.

However, this requires a change in the thought process throughout the organization regarding how to monitor, assess, and communicate performance. This includes not just the investment staff, but the investment committee as well as a sponsor’s management team and Board of Directors.

Accordingly, as a next step to our “First Take” analysis, we also compiled or estimated actual asset returns for a sample of 50 companies with December fiscal year-ends.1 This universe included some of our original 50 as well as some other companies. The distribution of those returns and other relevant metrics are detailed in Exhibit 8. Not surprisingly, the best performance during 2011 was from those plans with high fixed income allocations.

Exhibit 8: Most plans underperformed their expected return assumption during 2011Sample of 50 December year-end companies; S&P 500 US plans

Source: Goldman Sachs Asset Management, company reports.

Note that the evolution of changing the definition of success has multiple ramifications when evaluating actual plan asset returns such as those in Exhibit 8. As stated earlier, for plans that have moved to more of a liability-focused approach the distribution of returns, without considering liability performance, may not be relevant.2

However, it also has ramifications for plans that have not moved to more of an LDI focus and which are still primarily focused on return generation rather than liability hedging. Consider that investment strategy amongst the sample of plans in Exhibit 8 is likely quite divergent, with some almost entirely focused on LDI and others almost entirely focused on return generation. Given that mix of approaches, a broad peer group population based on simply asset size may not be appropriate.

0

5

-5

10

15

20

7.9%

5.1%3.5%

5.0%

0.7%

3.0%

0.5%

-2.6%

7.7%

14.5%

1st Quintile 2nd Quintile 3rd Quintile 4th Quintile 5th Quintile

Median Return 4.7%Mean Return 4.4%Standard Deviation 3.9%

Ret

urn

(%)



Expected returns are estimates of hypothetical average returns of economic asset classes derived from statistical models. There can be no assurance that these returns can be achieved. Actual returns are likely to vary. Please see additional disclosures. These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary.This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.

III. Return assumptions should remain under pressure, leading to multiple ramifications for plan sponsorsLong-term expected return on plan asset assumptions have been steadily declining in the corporate space for several years, as seen in Exhibit 9. This assumption has declined from an average rate of 9.0% in 2002 to 7.9% in 2010. While the average for the 50-company sample in our “First Take” results in Exhibit 5 was slightly more than 8.0% for 2011, implying perhaps an increase from the prior year, we expect that once all of the 2011 data is in this assumption will have likely edged lower again. Larger plans, such as those included in this sample, have historically used higher expected return assumptions than smaller plans. Once this information has been compiled for all companies in the S&P 500, consistent with the population for this historical series, the average rate will likely have fallen from 2010.

Exhibit 9: Corporate expected return assumptions have been steadily decliningS&P 500 US plans

Source: Goldman Sachs Asset Management, company reports.

We expect declines in this assumption will continue in the coming years. Exhibit 10 provides examples of companies that have already announced a lower expected return assumption for 2012.

Exhibit 10: Downward adjustments to EROA assumptions continuing in 2012Sorted by 2012 assumptions; US plans

Source: Goldman Sachs Asset Management, company reports and presentations.

Equ

al-W

eigh

ted

Ave

rage

Exp

ecte

d R

etur

n A

ssum

ptio

n (%

)

2002

9.0%

8.5%

8.3% 8.3%8.2%

8.1% 8.1%8.0%

7.9%

2003 2004 2005 2006 2007 2008 2009 2010

7.25

7.75

8.25

8.75

9.25

Expected Return on Assets Assumption (%)

Company Name Industry 2011 2012

3M Co. Industrial Conglomerates 8.50 8.25

Caterpillar Inc. Const., Farm Mach. and Trucks 8.50 8.00

Lockheed Martin Corporation Aerospace and Defense 8.50 8.00

United States Steel Corp. Steel 8.00 7.75

Exelon Corp. Electric Utilities 8.00 7.50

Ford Motor Co. Automobile Manufacturers 8.00 7.50

The Travelers Companies, Inc. Property and Casualty Ins. 8.00 7.50

MetLife, Inc. Life and Health Insurance 7.25 7.00

Reynolds American Inc. Tobacco 7.75 7.00

Prudential Financial, Inc. Life and Health Insurance 7.00 6.75

General Motors Co. Automobile Manufacturers 8.00 6.20


3 Note that the US plans of S&P 500 companies comprise about half of the total assets of the entire US corporate DB universe. Consequently, total contributions for all US corporate DB pension plans can be thought of as being roughly double those detailed in Exhibit 11.



The lowering of this assumption has been linked to, in some cases, asset allocation shifts that have occurred over the past several years, such as those previously detailed in Exhibit 6. The movement towards LDI strategies by a number of plans has led some plans to move assets from equities to fixed income. Given that long-term return assumptions for fixed income is below that of equities, these shifts have led to a lowering of this assumption for the overall portfolio.

However, some of these downward adjustments have also been linked to lower expected returns for individual asset classes given, amongst other reasons, lower long-term expectations for GDP growth and interest rates. It is this latter reason that has contributed to the decision by many public plans to lower this assumption despite the lack of movement to higher allocations to fixed income as seen in the corporate plan universe.

A number of state pension plans, including CalPERS, New York, Virginia, Colorado, Pennsylvania and Rhode Island have lowered this assumption in recent years for their plans, based on their public disclosures. Disclosures by other public plans indicate that many others are also considering lowering this metric.

Lowering this assumption has important ramifications for the financial reporting of these plans. On the corporate side, using a lower expected return assumption directly increases the amount of pension expense recognized by the sponsor. On the public side, since the discount rate for the plan liabilities is tied to this assumption, a lower expected return assumption results in a higher reported gross pension liability.

However, it also has important ramifications for plan design and contribution policy. To the extent that actual asset returns are expected to be lower in the future, that may enlighten plan design, benefit policies, and contribution policies.

IV. Contribution activity will be robust in 2012 and beyondSeveral corporate plan sponsors have disclosed notable contributions they expect to make in 2012. We expect to hear more US companies announce large contributions this year and again in 2013. A combination of low funded levels, the mechanics of mandatory contribution requirement calculations, and, in some cases, large cash balances on corporate balance sheets have created a confluence of events that we believe will lead to a significant rise in contributions over the next few years.

Exhibit 11 details our historical series of actual contributions to US DB plans by S&P 500 companies.3 While 2009-2011 saw a notable increase in contribution activity, much of this activity was of a voluntary nature. In other words, contributions were not driven by legal requirements, but rather companies elected to contribute cash into their plans.

There are certainly several reasons why a corporate plan sponsor would make voluntary contributions into their pension plans. These include the tax deductibility of the contribution, the ability to potentially lower mandatory contribution requirements in the future and the boost to reported earnings that arises from the contribution. While some cash rich plan sponsors will likely continue to make voluntary contribution requirements, a key change going forward for some plans is that notable mandatory contribution are now starting to kick in.


4 See “The Rising Tide of Pension Contributions Post-2008: How much and when? An analysis of funding for the U.S. private sector single-employer defined benefit system.” Society of Actuaries, 2011.



Exhibit 11: Contributions have risen in recent years, and will likely rise even more in 2012 and beyondS&P 500 US plans

* General Motors alone contributed $18 billion to its US pension plans in 2003 per its disclosure filing. This upwardly skewed total S&P 500 contributions for 2003.Source: Goldman Sachs Asset Management, company reports.

A 2011 report from the Society of Actuaries estimated that minimum required contributions will rise steadily between now and 2016, ultimately peaking at $140 billion that year.4 That represents approximately three times the amount of minimum required contributions in 2011.

A number of plan sponsors will be able to satisfy these contribution requirements through cash that is currently sitting on the balance sheet. Exhibit 12 details that the ratio of cash to assets for non-financial companies is at a 40-year high of just over 11%. Record corporate earnings in 2011 are expected to continue to rise in 2012, further augmenting cash balances.

Exhibit 12: Cash as a % of assets at high levels for non-financial corporationsBased on the largest 1,500 stocks excluding autos, financials and utilities; data smoothed on a trailing one-year basis

Source: GS Investment Strategy Group; Empirical Research Partners, as of November 2011.

However, these cash balances are, of course, not evenly distributed throughout the corporate world. Consequently, some plan sponsors that have forthcoming contribution requirements may not have the cash readily available. In other cases much of a plan sponsor’s cash holdings may be overseas and, therefore, may be subject to US taxation should the funds be repatriated.

1970 1978 1986 1994 2002 20104

6

8

10

12

Rat

io o

f C

ash

to A

sset

s (%

)C

ontr

ibut

ions

(in

$ B

illio

ns)

2002 2003* 2004 2005 2006 2007 2008 2010 2011(E)2009

0

10

20

30

40

50

60GM*

Putting excess cash to use and/or taking advantage of low interest rates to borrow and contribute.70


5 In addition to a number of companies that have issued debt to help fund their single-employer DB plans, Kroger even issued debt during early 2012 to help fund its multi-employer plans, per its disclosure filings.



Given the low interest rate environment, a number of companies have issued debt and used a portion of the proceeds to fund their pension plans.5 While low interest rates have been a bane to pension funding calculations given their impact on the value of liabilities, some plan sponsors have used this as a way to potentially make low interest rates work for them. More plan sponsors may explore this strategy given the expectation that interest rates will remain low in comparison to historical levels into the foreseeable future.

Finally, over the past several years we have seen a number of plan sponsors contribute company stock into their plans. This has included, for example, Alcoa, Honeywell, and United Technologies and, earlier during 2012, Xerox. ERISA generally permits up to 10% of a plan’s assets to be invested in qualifying employer stock. Some sponsors may view this as an attractive option given that it a) allows them to conserve cash for other uses and/or b) lets them take advantage of a rise in their share prices if they believe their stock is undervalued.

V. More corporate sponsors are likely to contemplate financial reporting changes given pension deficits and large unrecognized lossesThe trend of moving more towards a mark-to-market type of accounting and financial reporting framework will likely continue. This trend, which was first kicked off in late 2010 and early 2011 by Honeywell, AT&T and Verizon, saw additional companies adopt similar changes later in 2011 and in early 2012. This has included companies such as UPS, Windstream and First Energy.

We believe this trend may continue for several reasons. First, these changes make the performance of the plan and its impact on the plan sponsor more transparent and easier to understand. This has been cited by many companies as a primary reason for making the switch. The complexity of the pension accounting rules and regulations meant that senior members of management were often spending significant amounts of time addressing this issue with investors, creditors and other constituents.

Second, these changes move the financial reporting construct closer to international accounting financial reporting standards which, in one way, shape or form will likely work their way into US financial reporting in the future. We address this topic later in this report.

Third, the growing amount of unrecognized losses that many companies have been accumulating related to their defined benefit pension (and retiree healthcare plans) will result in rising pension expense in future years as a portion of these losses are recognized through the income statement. Indeed, at the end of 2010 we note that S&P 500 companies had over $350 billion of unrecognized losses related to their US DB plans. That figure moves even higher when unrecognized losses on non-US DB plans and retiree healthcare plans, which fall under the same accounting framework, are also considered.

These unrecognized losses rose for almost every company at the end of 2011 due to a) higher gross pension obligations due to the low interest rate environment and b) in some cases, actual plan asset returns that fell below the plan’s expected return on assets assumption. While not all of these losses will be recognized through earnings in the future, the larger the balance the more likely an increasing amount will be amortized, thereby placing upward pressure on reported pension expense and downward pressure on earnings per share. Moving to more of a mark-to-market reporting framework has allowed plan sponsors to restate some of these losses to prior periods as well as “true up” annual results in a fourth quarter charge that is subsequently backed out of pro forma earnings.

Finally, these financial reporting changes do not affect the gross size of the pension obligation, the funded status of the plan, or cash flow requirements. In other words, from a theoretical perspective, the changes should have no impact on valuation. They have, nonetheless, been well received by the investor community upon announcement. Part of this may be attributable to GAAP earnings being higher in the future as a result of the changes. The analysis in the blue box illustrates the positive equity market reaction around these announcements.


For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar results to those presented above can or will be achieved.This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.


Investors Tend to Warm Up to Pension Accounting ChangesOften, company announcements on pension-related issues are included as part of an earnings-related announcement, investor briefing, or other broad-based filing with the SEC. This makes it difficult to ascertain the market’s reaction to the pension-specific disclosure. However, several companies which have disclosed a move to a mark-to-market framework did so as a standalone announcement. This allowed us to observe how the market reacted to the specific news.

The first three companies that set off this movement towards mark-to-market accounting in late 2010 and early 2011 were Honeywell, AT&T and Verizon. In each of these cases the switch to a mark-to-market pension accounting framework was the only information publicly disclosed by the companies that day. In all three cases, each company’s stock price outperformed the broader market on the day of the announcement, as outlined in the first chart below. The outperformance by Honeywell, on a day when the market was broadly lower, was particularly striking.

Remember, in theory this change should have had no impact on valuation. After contemplating these changes post announcement did this reality set in for investors, thereby leading to subsequent underperformance? Apparently not. When evaluated over the week following the announcements all three companies still outperformed, as seen in the second chart. These positive returns by investors to the changes may provide another reason for plan sponsors to consider such options or, at a minimum, address a concern that effectuating such a change would adversely affect the company’s stock price.

Market reaction was generally positive on the day of announcement… …and persisted over the following week


1-Day % price change post announcement

1.8%

0.1% 0.2%

1.0%

-0.2%

-1.6%

S&P 500Company

Honeywell AT&T Verizon Honeywell AT&T Verizon

5-Day % price change post announcement

4.3%

0.7%

1.5%

5.4%

-0.4%

0.0%

Case Study


6 For additional information please see “How Would GASB Proposals Affect State and Local Pension reporting?”, November 2011, Center for Retirement Research at Boston College.



VI. Potential changes to regulatory and accounting standards will contribute to uncertainty for plan sponsorsWe believe potential funding relief for corporate DB plans as well as continued debate around financial reporting changes for corporate and public plans will highlight regulatory activity in 2012. Already this year we have seen much activity in Washington as a provision attached to the Senate’s highway bill would allow plan sponsors to use discount rates based on a 25-year average of long-term interest rates within a 10% band. Such a change would allow some plan sponsors to use a higher discount rate for funding calculations and alleviate some of the mandatory funding requirements facing plan sponsors.

Ever since the implementation of the Federal Reserve’s “Operation Twist” in 2011, plan sponsors have been calling on Washington to enact some sort of funding relief. As detailed earlier in this report, it has been low interest rates that have inflicted the most pain on the funded levels of corporate plan sponsors.

Momentum has been growing on both sides of the aisle for some sort of relief to be enacted. Certainly part of this is driven by the fact that such relief would be revenue positive from a tax perspective. Lower mandatory contribution requirements may mean lower actual contributions, since contributions are tax deductible, up to certain limits. Lower contributions would mean higher taxes. While a stopgap extension of transportation funding was passed by Congress in late March, discussions around the highway bill, with funding relief, will continue in the spring.

From a financial reporting perspective, both corporate and public plans will likely see activity during 2012. On the public side, the Governmental Accounting Standards Board (GASB) continues to deliberate several changes with an objective of improving accountability, transparency, and usefulness of information. One change in particular would alter the derivation of the discount rate used to value pension liabilities.

While today public plans use the expected return on plan assets assumption as the discount rate to calculate the present value of liabilities, the GASB proposal would call for a blended rate that reflects the expected return assumption for the portion of pension liabilities that are projected to be covered by plan assets, and a high-grade municipal bond rate for the portion that are not covered by plan assets. The result would likely be a lower discount rate for many plans in comparison to the rate that they are using today, thereby raising the present value of pension obligations.

The GASB has also proposed that the market value of plan assets be used in determining the funded status of the plan as opposed to using an actuarial smoothed method as many plans do today. These changes, if enacted as currently contemplated, would notably lower the reported funded ratios for state and local plans. Exhibit 13 details how 2009 and 2010 reported funded ratios, based on an analysis performed by the Center for Retirement Research at Boston College, would have been much lower had the GASB proposal been in place at that time.6




Exhibit 13: GASB proposal would notably change public sector reported funded ratios

Source: Center for Retirement Research at Boston College.

On the corporate side, the International Accounting Standard’s Board revision to IAS 19, the international standard for pension accounting, will, among other things, eliminate the use of the expected return assumption when calculating the amount of pension expense that must be recognized by the plan sponsor. Effective in 2013, this change does not affect those sponsors reporting under US GAAP.

However, we believe that in one way, shape or form this sort of accounting framework for pensions will likely work its way to the United States. The Financial Accounting Standards Board (FASB) could propose changes to pension accounting standards that would more closely align the US standards with the international regulations. This would likely involve a similar elimination of the expected return assumption.

Alternatively, the SEC could allow or require the use of international standards in the US. We expect to hear updates on both of these potential paths from both the FASB and the SEC during 2012.

Elimination of the expected return assumption would remove a powerful barrier to de-risking as plan sponsors would no longer have to worry about the earnings “hit” from lowering this metric. Any potential change, either from the FASB or the SEC, may likely not be effective for several years. However, as funded levels (hopefully) rise over the next few years, elimination of the use of this assumption coinciding with, potentially, a return to fully funded levels may likely lead many sponsors to execute LDI-type strategies, especially if their plans are frozen or closed.

VII. Pensions will remain the focus, but retiree health care will continue to gain attention as a growing issue in the retirement spaceWhile corporate and governmental pension plan sponsors have their hands full with pension-related issues, the “other” retirement liability issue, namely retiree health care benefits, has been gaining increased attention in recent years. This has been primarily due to:

Health care costs rising above the overall rate of inflation,

The unfunded nature of many of these plans,

Accelerating cash outflows as more participants retire and begin to collect benefits, and

As with pension plans, improvements in mortality which have led to larger obligations as benefits are paid to participants over a longer time period than originally contemplated.

2009 2010

25

50

75

100

79%

49%

77%

53%

GASB proposalCurrent

Agg

rega

te F

unde

d R

atio

s fo

r S

tate

and

Loc

al P

lans

(%)


7 For additional information, see the April 2011 report from the Pew Center on the States entitled, “The Widening Gap.” This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.


Retiree health care liabilities, which are commonly referred to as other post-employment benefits or OPEB, are smaller, in aggregate, than DB pension liabilities. However, the lack of funding requirements for these plans, for both corporate and governmental employers, means that many have little or no assets set aside to pay for these benefits. Consequently, the unfunded liabilities for retiree health care generally exceed those for defined benefit pensions. Indeed, Exhibit 14 outlines this funding gap between health care and pension liabilities for S&P 500 companies. While the total gross obligations for health care are just 25% of the total obligations for DB pensions, the underfunding for health care costs is still higher.

Exhibit 14: The Funding Gap for Retirement Benefits—a Growing ConcernS&P 500 US plans; 2010 data


While these liabilities are not ERISA protected and, therefore, have no mandatory contribution requirements, an aging society means that more participants are collecting these benefits. Indeed, some individual plans will see cash outflows for OPEB benefit payments increase notably in the coming years. Again, since many of these plans have little or no assets set aside today, that cash flow will need to come from the employer.

State and local OPEB plans face a similar story. According to the Pew Center on the States, state OPEB plans face an approximately $600 billion funding gap.7 As cash outflows for benefits accelerate, this presents, for some governments, an added pressure.

Given these factors, we expect retiree health care to receive increased focus from employers as they consider benefit levels, plan design, and the potential for pre-funding options. Despite the budgetary pressures being felt by many state and local governments, this may be especially true since pre-funding helps reported funded levels not only by raising plan assets, but also through lower gross obligations since pre-funding would allow for the use of a higher discount rate.

Pens

ion

and

OP

EB

Gro

ss O

blig

atio

ns

and

Fund

ed S

tatu

s (in

$B

illio

ns)

US DB pension OPEB

$1,286

$280

-$198 -$215

Funded StatusGross Obligation

-400

0

400

800

1200

1600




ConclusionThe last several years have been a trying time for sponsors of corporate DB pension plans. Among the contributing factors:

A shifting regulatory environment, in particular one that has moved the system to more of a mark-to-market framework, meaning that a negative change in funded status has a much more direct and immediate impact on the plan sponsor;

Increased market volatility across a number of different asset classes; and

Of course, persistently low long-term interest rates.

These challenges are not only to plan funded levels, but also in relation to how the plan affects the plan sponsor. This has led to an increased focus on pension plans from investors, bond holders, rating agencies and, of course, plan sponsors themselves.

Some of these challenges are leading sponsors to proactively change plan design, contribution policies and financial reporting, while fiduciaries are reconsidering investment strategy and asset allocation. Other regulatory and accounting changes may be thrust upon the pension landscape.

The sum of all of this is that plan sponsors may face a much broader array of challenges to deal with than in the past. We expect to see much activity in 2012 as plan sponsors seek to address many of these challenges.

Michael Moran is a pension strategist at Goldman Sachs Asset Management (GSAM). In this role, he produces original research and industry-leading thought leadership on topics such as plan funded status, contribution activity and dynamic asset allocation. He also works with clients to help them create customized solutions specific to their defined benefit and defined contribution plans. He previously was part of the Goldman Sachs Global Markets Institute within the Global Investment Research Division, advising corporate, government and investment clients on a wide range of issues related to capital markets, financial reporting, valuation, asset allocation and regulatory matters. Prior to joining the firm, he worked as a CPA for Ernst & Young LLP. He received a BS in Accounting from Villanova University and an MBA in Finance from New York University’s Stern School of Business, and is a CFA charterholder.


THIS MATERIAL IS PROVIDED SOLELY ON THE BASIS THAT IT WILL NOT CONSTITUTE INVESTMENT ADVICE AND WILL NOT FORM A PRIMARY BASIS FOR ANY PERSON’S OR PLAN’S INVESTMENT DECISIONS, AND GOLDMAN SACHS IS NOT A FIDUCIARY WITH RESPECT TO ANY PERSON OR PLAN BY REASON OF PROVIDING THE MATERIAL OR CONTENT HEREIN.This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark.Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.Confidentiality No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.Expected return models apply statistical methods and a series of fixed assumptions to derive estimates of hypothetical average asset class performance. Reasonable people may disagree about the appropriate statistical model and assumptions. These models have limitations, as the assumptions may not be consensus views, or the model may not be updated to reflect current economic or market conditions. These models should not be relied upon to make predictions of actual future account performance. GSAM has no obligation to provide updates or changes to such data. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.This material has been prepared by GSAM and is not a product of Goldman Sachs Global Investment Research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes.Goldman Sachs does not provide accounting, tax, or legal advice. Notwithstanding anything in this document to the contrary, and except as required to enable compliance with applicable securities law, you may disclose to any person the US federal and state income tax treatment and tax structure of the transaction and all materials of any kind (including tax opinions and other tax analyses) that are provided to you relating to such tax treatment and tax structure, without Goldman Sachs imposing any limitation of any kind. Investors should be aware that a determination of the tax consequences to them should take into account their specific circumstances and that the tax law is subject to change in the future or retroactively and investors are strongly urged to consult with their own tax advisor regarding any potential strategy, investment or transaction.


© 2012 Goldman Sachs. All rights reserved. 70591.OTHER.OTU USIWPPEN/04-12

Documents

Pension Review “First Take:” Highlights, Challenges and Changes …online.wsj.com/public/resources/documents/pensionreview.pdf · 2018-08-27 · Pension Review “First Take:”