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11/01/2013

Pensions take an Economic Hit

The U.S. economy has improved following the financial crisis of 2008-2009, but the twists and turns of U.S. interest rates continue to impact the grocery retail and food industry, extending their impact beyond sales and earnings to computations for long-term pension benefit liabilities.

Last year's headlines on this topic "were all about the de-risking activities companies took to reduce their pension obligations," according to the "2013 Pension Funding Study" from Seattle, Wa.-based Milliman.

"However, declining interest rates were once again the major story," reported Milliman study authors John Ehrhardt, Alan Perry and Zorast Wadia.

Simply put, that's because companies use current U.S. Treasury market rates to compute the cost of paying future pension obligations.

"The lower the discount rate, the higher the liability," says Mickey Chadha, vice president and senior analyst at Moody's Investors Service.

S&P 500 Pension and OPEB Funding Statistics for 2012
Source: S&P 500 2012 Pensions and OPEB: The Final Frontier By S&P Dow Jones Indices

In other words, companies watched as the low discount rate "negated the (increased) asset value in their plans," he says.

Concerns about funding post-employment plans are evident across sectors – from state and other municipal plans to corporate pension funds.

In a study of pensions and other post-employment benefits published earlier this year, S&P Dow Jones Indices and S&P Capital IQ found that global equity markets posted double-digit gains in 2012, with the S&P 500 up 13.41 percent.

"Gains were insufficient to counter the increase in costs due to artificially low interest rates, which increased the size of discounted liabilities," according to senior S&P Dow Jones index analyst Howard Silverblatt.

The S&P study showed from 2011 to 2012, pension underfunding increased from $355 billion to $452 billion, and the pension-funding rate decreased from 78.8 percent to 77.3 percent.

Signs of recovery

More recently, in the last six months, that scenario has improved as the discount rate increased–a "positive" for overall pension liabilities, Moody's Chadha says.

U.S. Treasury market rates have been soft as the U.S. Federal Reserve maintained a low-interest rate policy and conducted an extended program of buying Treasuries and mortgage-backed securities on the open market.

The Fed program, known as quantitative easing, was designed to invigorate the economy and fuel job growth. It also allowed a number of companies to restructure debt at lower interest rates.

A tapering of the Fed bond purchases was widely expected by year-end, although those expectations were deferred to 2014 after the two-week U.S. government shutdown in October Nevertheless, U.S. bond rates are higher than they were at the start of the year. The benchmark U.S. Treasury 10-year note, for example, closed around 1.84 percent on Jan.1, 2013 and at 2.66 percent on Oct. 1.

A widely followed pension funding index published by Milliman shows that after three consecutive months of funded ratio improvements, the funded ratio dipped to 89.4 percent in August.

The Milliman index reflects the 100 largest defined-benefit pension plans sponsored by U.S. public companies.

The $162 billion pension deficit for the Milliman 100 Pension Funding Index (PFI) is still a marked improvement over the $513 billion pension deficit from 12 months ago, the company said in a release.

For the grocery retail sector, "concerns (about pension underfunding) were much greater a couple of years ago," before the strong market rally, says Joseph Agnese, equity analyst at S&P Capital IQ. However, "it's still something we are keeping an eye on, especially if the market is weaker," he adds.

S&P 500 Historical Pension Data
Source: S&P 500 2012 Pensions and OPEB: The Final Frontier By S&P Dow Jones Indices

Among the grocery retailers he follows, Agnese says his only current sell recommendation is for Safeway Inc. "That's because there are poorly positioned, pricewise, in their core market" of California, he says.

A Rocky Five Years

For companies in the S&P 500 as a group, defined-benefit plans were fully funded in 2007, having recovered from the bear market of 2002, with $63.4 billion in excess assets over obligations, the S&P study showed. That represented a funding level of 104.4 percent of obligations.

But the financial crisis of 2008-2009 changed that scenario. "The net result was that for 2008, the S&P 500 declined to an underfunding record level of $308.4 billion, from an overfunding of $63.4 billion," the report notes.

The markets rebounded from a low set in March 2009, and continued to perform well in 2010, but the S&P report said the gains "were no match for the massive damage done to pension fund portfolios in 2008, when equity investment levels were much higher."

All funds are not the same

When comparing pension fund liabilities, it's important to point out there are two kinds of pension funds sponsored by grocery retailers: defined-benefit pension plans, and multi-employer plans formed through collective bargaining agreements between unions and companies.

Defined-benefit plans, or traditional pensions, are limited to a single employer. Multi-employer benefit plans are managed by a board that is appointed by contributing employers and participating unions, and are subject to the Labor Management Relations Act of 1947, also known as the Taft-Hartley Act.

S&P 500 OPEB Asset Allocations in 2012
Source: S&P 500 2012 Pensions and OPEB: The Final Frontier By S&P Dow Jones Indices

Multi-employer pension plans are a much larger issue for grocery companies, notes Moody's Chadha.

Both plans have benefits and risks. Interest-rate risk is a bigger issue for defined-benefit plans, while multi-employer plans are especially challenged by the risk of companies withdrawing from the plans.

A survey released in July by Pyramis Global Advisors, a Fidelity Investments company, showed 37 percent of the nation's largest union pension plans do not believe that existing multi-employer pension system will survive current pressures.

The survey respondents cited lower interest rates and investment volatility as key challenges. Other factors include declining union membership, rising benefits obligations and legislative challenges, and the departure of sponsoring companies from the system.

In the Pyramis Global Advisors survey, "respondents tell us they see a future of different models with changes in the responsibilities of different parties in the process," said Mike Jones, president of Pyramis, in a release.

The obligations of participating employers are joint and several, "meaning that all employers in the multi-employer pension plan are equally responsible for the total obligations of the fund irrespective of the relative participation of their employees, or whether it's a stronger firm, or a weaker one," Chadha says.

That "last man standing" risk is partly why some grocery retailers have downsized their plan involvement.

Kroger Co., for example, announced in December 2011 that it would merge four of the UFCW/multi-employer pension funds to which the company contributes into a new fund as of Jan.1, 2012. The change reduced Kroger's annual pension contribution expense.

Kroger's repositioning was well received by analysts. Chadha noted Kroger was the majority funder in some of its plans, so its move to consolidation of the funds was fairly straightforward.

In contrast, Supervalu grocery chain executive Michele Murphy told a U.S. House panel in June that her company contributes to 20 multi-employer defined benefit pension plans.

That is despite Supervalu's sale of several of its banners in a restructuring early this year – Albertsons, Acme, Jewel-Osco, Shaw's and Star Market stores – to AB Acquisition LLC, an affiliate of a Cerberus Capital Management-led investor group, for $3.3 billion.

Supervalu's Murphy called on Congress to enact changes to rules governing multi-employer plans, allowing a plan's board "to implement a program that would suspend benefits, even to retirees, if doing so would prevent the plan from becoming insolvent" and preserve the plan for its participants.

But congressional action on changes in the pension funding rules for private companies is unlikely to take place soon.

For fiscal 2012, Supervalu reported a loss of $1.04 billion, including a $519 million operating loss and $509 million in interest expense. Sales fell 3 percent, to $27.9 billion. Murphy said Supervalu's participation in a trucking industry multi-employer fund dates back to the 1960s, before rule changes made by the Employee Retirement Income Security Act of 1974 (ERISA) and the Multiemployer Pension Plan Amendments Act (MPPAA).

But since then, dramatic consolidation has occurred in the retail food and trucking industries, Murphy said. That tightening "was exacerbated by the 2001 tech bubble and the 2008 stock market crash," she added in her testimony.

"Much of the current multi-employer plan underfunding is the direct result of these market events, as well as the structural problems inherent in ERISA and MPAA," she said. "All of these factors have resulted in reduced plan funding levels and lower[ed] contribution streams."

Freelance writer Suzanne Cosgrove has served as real-estate editor for the Chicago Tribune and as the Chicago bureau chief for Market News International.