Benefits and Compensation

Moody’s: Interest Rate Hike Could Lift Pensions to Full Funding by 2018

The first of what is expected to be a series of interest rate increases by the U.S. Federal Reserve on Dec. 16 should start to help defined benefit retirement plans recover from years of underfunding, Moody’s Investor Service said in a report Dec. 14.

Pension funding levels for about 670 rated U.S. non-financial corporate pension liabilities remain below the required level of 80 percent, but if interest rates move higher, as Moody’s expects, and asset returns remain consistent, pension plans could reach fully funded status in 36 months. The report, available by subscription, is titled “Pension Underfunding to Shrink in Next Three Years.”

“Since 2008, pension benefit obligations have increased significantly, with discount rates being a major contributing factor,” Wesley Smyth, a Moody’s vice president and senior accounting analyst, said in a press release. “Despite asset returns averaging an impressive 10 percent per annum since 2008, we believe the funding status of U.S. non-financial corporate pension plans will end this year at 78 percent.” That level is virtually unchanged from December 2008, at the start of the global financial crisis. Between 2008 and 2014, pension discount rates fell 250 basis points.

Moody’s said it estimates these pensions to be underfunded by $450 billion by the end of 2015.

DB plans struggle to maintain required funding levels amid low interest rates, and many companies have had to inject financial reserves into their plans to keep from falling into underfunded status — traditionally regarded as a ratio below 80 percent. Plans with assets below that level may have trouble meeting obligations to retirees and other beneficiaries, or face benefit restrictions established by the Pension Protection Act of 2006.

The Federal Reserve voted unanimously on Dec. 16 to raise interest rates by a quarter point, marking the first increase in more than nine years. The bank raised its fed funds rate to a range of 0.25 percent to 0.5 percent, ending an unprecedented seven-year run of near-zero interest rates. The board of directors also raised the discount rate to 1 percent from 0.75 percent.

Moody’s said projected benefit obligations of plans sponsored by its rated issuers have climbed by $703 billion to an estimated $2.1 trillion by the end of 2015. The agency estimated that $342 billion of the increase was driven by lower discount rates in recent years.

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