wp_gsam pension review halftime highlights

7/31/2019 WP_GSAM Pension Review Halftime Highlights

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1See ‘Pension Review “First Take:” Highlights, Challenges and Changes for 2012.” April 2012.

This material has been prepared by GSAM and is not a product of Goldman Sachs Global Investment Research. This material is providedfor educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. Thisinformation 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.

Executive SummaryCorporate dened benet (DB) pension plans have faced signicant headwinds in

today’s environment. These challenges include low funded levels due primarily to low

market interest rates, increasing contribution requirements and expense recognition for

plan sponsors, and declining future return assumptions for plan assets.

Heading into the second half of 2012, we nd that many of the same challenges and

changes that we wrote about earlier this year have continued to play out, or come to

fruition.1 Interest rates continue to grind lower, funding decits remain elevated, and

Congress has stepped in to provide near-term relief on funding requirements.

This “Halftime Highlights” paper provides an update on topical pension issues as well

as observations from our completed annual review of all the pension plans of S&P 500

companies. These include:

■ Ongoing stresses for plan sponsors, as underfunded pensions negatively impact

balance sheet liabilities, recognized pension expenses, and contribution requirements.

■ Continuing de-risking activities, which likely will not be slowed to any great degree by

the recent funding relief passed by Congress.

■ Growing unrecognized losses, due primarily to falling interest rates, which have

contributed to more plan sponsors adopting mark-to-market accounting for pensions.

■ Lowering of assumptions for expected future returns on plan assets.

Michael A. Moran, CFA

Pension Strategist

Goldman Sachs Asset

Management (GSAM)

Halftime Highlights:

Corporate Pension Plans Face Ongoing Stresses

White PaperAugust 2012


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Halftime Highlights: Corporate Pension Plans Face Ongoing Stresses

2 | Goldman Sachs Asset Management

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

Stresses On Corporate DB Plans ContinuingAggregate funded status for the US plans of S&P 500 companies ended the first half of 2012

around 79%, consistent with the level at the end of 2011 (see Exhibit 1). Yet these levels are

lower than those from earlier in 2012, reflecting the deteriorating environment since the spring.

While most equity markets posted positive total returns in the first half of 2012, falling interest

rates, yet again, have placed downward pressure on discount rates. This has, yet again, inflated

reported pension obligations and restrained improvement in funded levels. The median US planis funded around 75%.

Exhibit 1: Low interest rates are keeping a lid on funded levels

S&P 500 US Plans

60

70

80

90

100

110

A g g r e g

a t e G A A P F u n d e d ( % )

2002 2003 2004 2005 2006 2007 2008 2009 20112010 2012(E)

YTD

84%

90%92%

93%

101%

108%

79% 79% 79%

82%

85%

Source: Goldman Sachs Asset Management; company reports; as of June 30, 2012.

These depressed funding levels are contributing to large increases in recognized pension

expenses. Indeed, Exhibit 2 details that the aggregate pension expense in 2011 is at historically

high levels. Some of the increase in 2011 was from plan sponsors moving to a mark-to market

framework and therefore recognized large losses generated during the year. But many other

plans have seen the amortization of deferred losses increase, placing upward pressure on

pension expenses.




Goldman Sachs Asset Management | 3


Exhibit 2: Pension expense is an ongoing headwind for plan sponsors

S&P 500 US Plans

-5

0

5

10

15

20

25

30

3540

45

50

2011201020092008200720062005200420032002

S & P 5 0 0 P e n s i o n E x p e n s e / ( I n c o m e )

( i n $ B i l l i o n s )

-$0.8

$22.3$25.8

$28.4

$37.4

$22.9

$16.7

$32.4 $32.0

$45.3

Pension expense will likelycontinue to stay at elevatedlevels in future years.

After the 2000-2002 downturn,pension expense did notpeek until 2006.

Source: Goldman Sachs Asset Management; company reports as of December 31, 2011.

In addition, large funding deficits for many plans equate to large contribution requirements for

the plan sponsor. Despite the funding relief passed by Congress earlier this summer, which weaddress later in this paper, actual contributions during 2012 will likely remain elevated. Exhibit

3 details our historical series of actual contributions to US DB plans by S&P 500 companies

combined with our forecast for 2012, taking into account the aforementioned funding relief.

Exhibit 3: Contribution activity expected to be robust even with funding relief

S&P 500 US Plans

0

10

20

30

40

50

60

70

2012(E)2011201020092008200720062005200420032002

C o n

t r i b u t i o n s

( i n

$

B i l l i o n s )

GM*

39.3

65.8

46.9 46.8

37.4

25.729.4

54.558.4

54.5 55.0

Source: Goldman Sachs Asset Management; company reports as of December 31, 2011. * General Motors alone contributed $18 billionto its US pension plans in 2003. This upwardly skewed total S&P 500 contributions for 2003.






De-Risking by Corporate Plans Continues and Taking Multiple FormsAggregate actual and target asset allocation disclosures by S&P 500 companies highlight the

ongoing de-risking trend with corporate DB plans. Exhibit 4 details the multi-year movement out o

equities and into fixed income and “other,” which for many plans includes alternative investments

Target asset allocation disclosures in Exhibit 5 comparing these figures from 2002 and 2011

provide additional evidence of the conscious shift in strategies by many plan sponsors.

Exhibit 4: Corporate DB asset allocation has shifted over time

0

10

20

30

40

50

60

70

2002

84%

2003

90%

2004

92%

2005

93%

2006

101%

2007

108%

2008

79%

2010

85%

2011

79%

2009

82%Funded

Stable allocation to equities took a

sharp 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

Equity Debt Other Real Estate

45%

40%

11%

4%

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

42

39

15

4 A s s e t - W

e i g h t e d A c t u a l A s s e t A l l o c a t i o n s ( % )

Some plans have increased allocations to

alternatives to seek to better diversify their

return-seeking assets


Exhibit 5: Target allocation disclosures highlight multi-year shift by corporate plans

S&P 500 US Plans

Equity

45%

Debt

40%

Equity

59%

Debt

31%

Other5%

Real Estate

4%

Other

11%

Real Estate

4%

2002 2011


The de-risking theme took a new turn in the spring with General Motors’ lump sum offering

and annuity purchase involving over 100,000 participants. While this was certainly not the first

time a plan sponsor had instituted a lump sum option and/or had entered into an annuity buy-outtransaction, the size of the actions were unprecedented.





2For more information, plese see our Market Insights piece from June 2012, “Corporate Pension Plans: How to Think about Lump Sumsand Annuities.”

Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation


The GM move highlights that de-risking can take many forms and that there is no “one size fits all”

strategy. For example, some plans may find lump sum and annuity strategies attractive de-risking

options as they reduce the gross pension obligation. For other plans, the potential accounting

costs and cash flow requirements may outweigh the benefits. Exhibit 6 details some of the factors

a plan sponsor may want to consider as it contemplates various de-risking strategies.2

Exhibit 6: There is no “one size ts all” de-risking strategy—each has a unique set

of considerations

De-Risking

Strategy

L u m p S u m s

Purchase Annuityin the Plan (“buy-in”)

Full or Partial Termination(“buy-out”)

L D I

I Lowers gross pension obligation

I Lowers amortization of losses

I Transfers risk to third party

I Potentially lowers funded

percentage

I Recognition of settlement losses

I Cost > liability

I Asset of the plan

I No reduction in obligation

I No settlement loss

I Ongoing amortization of losses

I Potential for lower EROAassumption

I Cost > liability

I Lowers gross pension obligation

I Potentially lowers funded

percentage

I Risk of adverse selection

I Recognition of settlement losses

I Need for liquidity

I Impact on participant

I Assets of the plan

I No settlement loss

I No reduction in pension obligation

I Ongoing amortization of losses

I Better match for liabilities

I Low interest rate environment

Source: Goldman Sachs Asset Management. For Illustrative Purposes Only.

The recent funding relief passed by Congress has raised the question as to whether this new

legislation will slow down, or perhaps reverse, de-risking activities and implementation of liability-

driven investment (LDI) strategies. The relief does move the funding regulations farther away from

a mark-to-market system. Over the next few years if interest rates rise, lowering the market value

of fixed income plan assets, plan liabilities would not decline by a commensurate amount since

the discount rate would be based on a long-term average of interest rates.

While this relief may slow some de-risking activities, it likely does not end them. There are some

implications to consider, including: (1) how lower contributions into corporate DB plans may affect

the demand for financial assets, in particular long duration fixed income, and (2) whether existing

asset allocations will shift in response to the relief.





We believe the funding relief will do what it was intended to do—lower mandatory contribution

requirements over the next few years. The Society of Actuaries estimates that required contributions

could be reduced by an average of $45 billion per year over each of the next four years.3

However, the magnitude of the actual reductions in contributions over the next several years

versus previous expectations is more difficult to ascertain. Estimates from the Joint Committee

on Taxation imply actual annual reductions of around $10 billion - $20 billion for each of the next

several years. If reality is somewhere in the middle, this would imply around $30 billion fewercontributions into these plans over each of the next several years.

Many plans have used contributions in recent years to increase fixed income allocations as part of

their own glide path strategies. Lower contributions could then, at the margin, reduce some of the

demand over the next few years for long duration fixed income

Whether plan sponsors would implement changes to existing asset allocations as a result of

funding relief, perhaps to reverse some of the LDI strategies they have adopted in recent years,

may be a more challenging proposition for a number of reasons. First, the relief is essentially

temporary, as the ability to use higher discount rates than under the current rules will likely

diminish over time.

The new rules will allow plan sponsors to use rates tied to a 25-year average of interest rates,

subject to a corridor, as opposed to a two-year average. However, per the new law the corridorwidens over time. In addition, low interest rates in current periods will replace high interest rates

from older periods, thereby reducing the 25-year average. These two factors mean that over time

the rates used for discounting purposes will likely transition back to the two-year average.

As outlined in Exhibit 7 , we evaluated the likely path of future discount rates based upon

projections made by the Society of Actuaries, assuming no change to market interest rates in the

future. The line at the bottom represents the two-year average which, until recently, was the rate

used for funding purposes. To the extent this rate is below the corridor of rates based on a 25-yea

average of interest rates, the applicable discount rate would be adjusted upward to the bottom of

the corridor.

As seen in the exhibit, by 2016 the bottom of the corridor is almost the same as the two-year

average, essentially meaning that the rules have reverted to the previous construct. Obviouslyactual results in the future would be based upon the path of future interest rates.

3See “Proposed Pension Funding Stabilization: How Does It Affect the Single-Employer Dened Benet System?” © 2012 Society ofActuaries, Schaumburg, Illinois.

The economic and market forecasts presented herein [have been generated by GSAM/ are based on proprietary models] forinformational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please seeadditional disclosures at the end of this presentation.






3For more on the funding relief and its impact on plan sponsors, please see our Market Insights piece from June 2012, “Congress Closeto Providing Near-Term Pension Funding Relief, But Challenges Remain.”

The economic and market forecasts presented herein [have been generated by GSAM/ are based on proprietary models] forinformational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please seeadditional disclosures at the end of this presentation.

Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation.


Exhibit 7: Discount rates likely to converge towards the two-year average over time

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

201720162015201420132012

25 Yr Avg Corridor Max

25 Yr Avg Corridor Min

2 Yr Avg

I n t e r e s t R a t e s

Corridor

Source: Goldman Sachs Asset Management; Society of Actuaries.

Second, this is certainly not the first time that Congress has stepped in to provide DB funding

relief. While the Pension Protection Act of 2006 tightened funding requirements, separate

Congressional actions in 2008 and 2010 provided temporary relief for sponsors of DB plans.

The potential for funding relief is, in some ways, always hovering over the corporate DB universe.

Indeed, the relief just passed in Washington is very similar to the proposal first floated by the

American Benefits Council in the fall of 2011 and which was included in the Senate’s version of

the transportation bill passed in March. As plan sponsors institute multi-year de-risking activities,

the potential for funding relief is always part of the equation and likely to have been considered as

part of planning strategies.

Third, the funding relief does not impact the setting of discount rates for financial reporting

purposes. The funded status reported on the balance sheet - and the pension expense recognized

through the income statement - is still dependent on discount rates based on market interest rates

in effect at the end of a plan sponsor’s fiscal year. Minimizing financial reporting volatility, to the

extent it is a consideration in LDI strategies, is unaffected by the rule changes passed by Congress

Finally, some plan sponsors have been transitioning to LDI programs over the past several years.As previously seen in Exhibit 4 , movements out of equities into fixed income began as far back

as 2006. Many plan sponsors regularly committing to LDI programs will likely stay the course,

despite this temporary change to funding regulations. 3





The economic and market forecasts presented herein [have been generated by GSAM/are based on proprietary models] for informationapurposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additionaldisclosures at the end of this presentation.

Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation.


Growing Unrecognized Actuarial Losses May Contribute To MoreMark-to-Market MovementsS&P 500 companies had almost $440 billion of unrecognized losses on their US DB plans at the

end of last year. That figure is even greater when unrecognized losses from non-US DB plans and

retiree health care plans are included. Much of these losses have been generated in recent years

from gross pension obligations rising due to falling interest rates.

Amortization of these losses in the future could increase reported pension expense and decrease

GAAP earnings. Moving to more of a mark-to-market system results in a more immediate

recognition of gains and losses and reduces the amortization effects in the future. For some plans

these deferred losses are quite material. Exhibit 8 highlights that more than 20% of the companies

in the S&P 500 with US DB pension plans had unrecognized actuarial losses greater than 10% of

the company’s market capitalization.

Exhibit 8: Unrecognized actuarial losses are quite material for some plan sponsors

0

5

10

15

20

25

30

35

40

> 10%8% - 10%6% - 8%4% - 6%2% - 4%< 2%

% o

f S & P 5 0 0

C o m p a n i e s

36.2%

19.5%

10.4%

5.5% 6.8%

21.5%

Unrecognized losses as a % of market capitalization

Source: Goldman Sachs Asset Management; company reports, as of December 31, 2011.

As we highlighted in our April white paper, as these unrecognized losses grow it may provide

more incentive for some plan sponsors to consider switching to more of a mark-to-market financia

reporting system similar to what had previously been adopted by companies such as Honeywell,AT&T and Verizon. Indeed, ConAgra Foods and Johnson Controls became two of the most recent

examples of plan sponsors moving to such a financial reporting structure as both announced

financial reporting changes along these lines recently.

For some plan sponsors, the conversation around a potential move to a mark-to-market reporting

framework may have moved from “Why would we do this?” to “Why wouldn’t we do this?” We

believe more plan sponsors may contemplate such changes as we move closer to year end and

companies begin working through 2012 year-end reporting and 2013 earnings guidance.





These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results mayvary substantially.

Expected returns are estimates of hypothetical average returns of economic asset classes derived from statistical models. There can beno assurance that these returns can be achieved. Actual returns are likely to vary. Please see additional disclosures.


Expected Return Assumptions Remain Under PressureThe average expected return assumption for a US corporate plan has been steadily declining over

the past decade, falling to a low of 7.7% at the end of 2011 (Exhibit 9 ). Some of the declines have

been linked to the shifts in asset allocation and investment strategy previously outlined in Exhibits

4 and 5 . Some of the declines are likely also partially attributable to lowered expectations for

global GDP growth and interest rates.

Exhibit 9: Corporate expected return assumptions have been steadily declining

S&P 500 US Plans

6.25

6.75

7.25

7.75

8.25

8.75

9.25

2011201020092008200720062005200420032002

E q u a l - W e i g h t e d A v e r a g e

E x p e c t e d R e t u r n A s s u m p t i o n ( % ) 9.0%

8.5%

8.3% 8.3%8.2%

8.1% 8.1%8.0%

7.9%

7.7%

Source: Goldman Sachs Asset Management; company reports; as of December 31, 2011.

Another way to document the decline in expected return assumptions is to view the distribution

of assumptions used in any year. Exhibit 10 displays that distribution for 2002 and 2011. Note that

while two-thirds of S&P 500 companies used an expected return assumption of 9% or higher in

2002 for their US DB plans, that percentage fell to less than 2% in 2011.

Exhibit 10: Very few plans still use expected return assumptions of 9% or higher

0

10

20

30

40

50

60

70

80

9.00% or highe8.50% - 8.99%8.00% - 8.49%7.50% - 7.99%7.00% - 7.49%6.99% or lower

% o

f S & P 5 0 0 C o m p a n i e s

( U S p l a n s o n l y w h e n s p e

c i fi e d )

1.2%

11.9%

2.0%

12.5%

2.6%

25.3%

9.4%

35.9%

17.0%12.5%

1.9%

67.8%

2002

2011

Source: Goldman Sachs Asset Management; company reports. As of December 31, 2011.





The economic and market forecasts presented herein [have been generated by GSAM/are based on proprietary models] for informationapurposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additionaldisclosures at the end of this presentation.

These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results mayvary substantially.


Exhibit 11: Widening Gap between ROAs and 10-year Treasury Yields

S&P 500 US Plans

Source: Goldman Sachs Asset Management, US Treasury. As of December 31, 2011.

While Exhibits 9 and 10 clearly demonstrate the downward trend in expected return assumptions,

it can be argued that these figures should move even lower given the low interest rate

environment. Exhibit 11 notes that the spread between the average expected return assumption

and the 10-year Treasury yield is at almost its highest level over the past 10 years. Note that the

average difference during this period was 453 basis points versus 581 at the end of 2011. We

expect the downward trend in expected return assumptions to continue. Indeed, a number of

corporate (and public) DB plan sponsors have already announced reductions to this assumption

for 2012.

ConclusionOur annual review of pension data for S&P 500 companies and recent actions by plan sponsors

and legislators confirm many of the challenges and changes we see impacting plan sponsors.

Unfortunately many of these trends—low funded levels, high recognized pension expense,

and large contribution requirements, despite the recent funding relief—will likely remain for the

foreseeable future. We expect to see more plans taking proactive steps to meet these challenges,

such as continuing de-risking activities and adjusting financial reporting practices.

0

100

200

300

400

500

600

700

2011201020092008200720062005200420032002

B a s i s p o i n t d i f f e r e n c e b e t w e e n

a v e r a g e E R O A a s s u m p t i o n a n d 1 0 - y e a r

U S T r e a s u r y y i e l d

517

423406

391

349

406

585

415

460

581






For more information please contact your Goldman Sachs

Asset Management relationship manager.

About the Author

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.



Disclosures

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’SINVESTMENT 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 TODO 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 asof 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 specied period of time are provided for your information only and do not imply that theportfolio will achieve similar results. The index composition may not reect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reectsappropriate 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 assumedwithout independent verication, the accuracy and completeness of all information available from public sources.

Past perormance does not guarantee uture results, which may vary. The value o investments and the income derived rom investments will uctuate and can godown as well as up. A loss o principal may occur.

Economic and market forecasts presented herein reect our judgment as of the date of this presentation and are subject to change without notice. These forecasts do not take intoaccount the specic investment objectives, restrictions, tax and nancial situation or other needs of any specic client. Actual data will vary and may not be reected here. Theseforecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possibleoutcomes. These forecasts are estimated, based on assumptions, and are subject to signicant revision and may change materially as economic and market conditions change. GoldmanSachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.

Confdentiality

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 anemployee, ofcer, director, or authorized agent of the recipient.

Expected return models apply statistical methods and a series of xed assumptions to derive estimates of hypothetical average asset class performance. Reasonable people may disagreeabout 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 reectcurrent 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 orchanges 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 orinvestment 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 SachsGlobal Investment Research or other departments or divisions of Goldman Sachs and its afliates. Investors are urged to consult with their nancial advisors before buying or selling anysecurities. 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 applicablesecurities 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 andother 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 adetermination of the tax consequences to them should take into account their specic circumstances and that the tax law is subject to change in the future or retroactively and investorsare strongly urged to consult with their own tax advisor regarding any potential strategy, investment or transaction.

© 2012 Goldman Sachs. All Rights Reserved. 78016.OTHER.OTU WPCORPPENSION/08-1

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