Accounting, regulatory, and market forces will lead to 50% to 75% of all private-sector defined benefit assets in the United States to be frozen or terminated over the next five years, according to a report by McKinsey & Company.
The report, entitled The Coming Shakeout in the Defined Benefit Market, says the Pension Protection Act’s new funding rules, which begin to take effect in 2008, give companies much less leeway in calculating how much companies must contribute to their DB plans.
And future volatility concerns are of great concern to plan sponsors. “After all, it was only recently that a cratering stock market and falling interest rates forced companies to pump massive amounts of cash into their plans: after years of enjoying low(or no)contributions, DB sponsors within the S&P 500 were forced to contribute a total of US$228 billion between 2002 and 2005 alone—and that was under the old, less stringent, regulations,” states the report.
Another factor which could lead to freezing of DB plans is the new accounting rules implemented by the Financial Accounting Standards Board. The regulation could force many companies to recognize a major new liability, either now or in the future. The second phase of FASB’s pension review, expected in the next three years, could bring pension volatility to new heights. It is widely expected that FASB will require companies to mark-to-market the value of their pension assets and liabilities.
“Given the often extreme short-term fluctuations of the stock and bond markets, such a measure could severely curtail earnings,” the report says. “For example, Credit Suisse estimates that aggregate S&P 500 earnings would have plunged 69% in 2001 if a market-based methodology had been applied to pension assets and liabilities.”
Due to the volatility created by the new accounting and funding regulations, McKinsey predicts that many plan sponsors will instead attempt to “lock in” their healthy funding levels by freezing their DB plans and adopting new investment strategies that better align pension assets with liabilities in order to shield corporate financial statements from the unpredictability of pension valuations.
But contrary to conventional wisdom, the report says the DB market is hardly dead, which should bring about the most significant growth and profit opportunities in decades—for the right players.
Also, McKinsey predicts a three-way race between asset managers, insurers, and investment banks will be under way by 2012. “No single type of firm currently possesses the requisite set of skills to provide comprehensive solutions to DB plan sponsors,” states the report. “As such, we expect to see players from all three sectors making the necessary strategic moves to build, joint venture or acquire them over the next three to five years.”
To download the report from McKinskey & Company’s site, click here.
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