Have you been wondering what these extremely low interest rates are doing to pension plans?  Quite simply, they are driving up funding obligations of employers.  Fitch Ratings issued a report noting that companies with underfunded pensions will remain subject to pressure going forward.

Where this gets sad is that even if interest rates remain low, funding requirements could continue to rise.  So here is the question to ask… Will companies start killing or limiting their pension systems using the low interest rates as an excuse?  After all, a company has to be able to depend upon consistent returns in the bond market and stock market through time. 

Fitch believes that liabilities in pension funding rules could still continue to grow and using a 24-month average of yields on high quality corporate bonds provided by the U.S. Department of the Treasury showed that the index fell from 5.88% in December 2009 to 4.71% in December 2011.  Even if market rates stay flat, this index could continue to decline in 2012.

What employees have to worry about is that cash contributions will remain elevated barring a significant recovery in the equity market.  Fitch expects that stronger companies will be able to meet their higher obligations and some will actually contribute more than minimal levels.  The flip-side is that companies with weaker credit profiles or underfunded plans will continue to face funding challenges.

This quote shows more concerns: “even if there is some improvement in asset performance amid a low interest rate environment, that doesn’t necessarily alleviate funding pressure… company pension funding ails won’t necessarily be cured by a moderate uptick in the equity markets.”

The bottom line: a 50-basis-point decrease in the funding calculation discount rate could raise a plan’s sponsor liabilities by 5% to 10%. Ouch!

This is just one more unintended consequence of very low interest rates. 

JON C. OGG

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