Rising interest rates have boosted corporate pensions, with funded status reaching a 20-year high in the second half of last year. But rising rates may not prove so kind to companies, from Delta Air Lines Inc. to Sysco Corp., and their pension costs this year.
High interest rates are generally good for pensions because they bring liabilities down and improve funded status, said Matt McDaniel, a partner at consulting firm Mercer LLC who advises companies on pension risk and strategy. The liabilities are based on long-term corporate bond yields, or discount rates, and decrease when bond yields rise. Defined-benefit plans sponsored by S&P 1500 companies were 103% funded as of Jan. 31, up 6 percentage points from the prior-year period, according to Mercer.
The news isn’t all good, however, as the Federal Reserve continues to raise rates, even if at a milder pace. Within the last year, interest rates rose significantly while asset values fell, driving up pension accounting costs. This is because as rates go up, so too does the interest cost on obligations in defined-benefit pension plans, pushing companies’ costs up, according to Mr. McDaniel.
That is showing up now for some companies, he said, because plan sponsors generally measure pension expenses at the end of their fiscal year. Plan sponsors that measured these costs at the end of 2022, for instance, saw much higher interest rates than a year earlier, he said, which pushes 2023 balance sheet costs up.
In short, said Joanie Roberts, senior director of retirement at advisory firm Willis Towers Watson PLC, many plan sponsors this year will see increased costs they will need to recognize in their accounting, primarily driven by higher interest rates and lower expected returns on pension assets because of the volatile market last year.
Take RPM International Inc., whose U.S. pension costs increased to around $13 million for the company’s fiscal 2023 second quarter ended Nov. 30, compared with roughly $9.6 million in the year-earlier period. The higher costs were driven by a reduction in return on plan assets and higher interest costs, which were only partially offset by higher discount rates, the building materials maker said in a regulatory filing last month.
“Corporate costs are up primarily from two categories: It’s pension and insurance,” RPM Chief Financial Officer Russell Gordon told analysts in early January. “In terms of pension, our assets have been hit in the pension plan, and that leads to higher nonservice-related pension costs.”
Delta Air Lines in January said its 2023 nonoperating expense is expected to go up year-over-year because of its noncash pension expense increasing more than $550 million. Manufacturing company 3M Co. indicated last month that its pension cost was up $125 million from a year earlier.
Bank holding company WesBanco Inc. in January said it expects a higher pension expense of roughly $1 million per quarter this year. This is because of an expected lower return on pension assets, CFO Daniel Weiss told analysts in January.
Meanwhile, food distribution company Sysco last month said its adjusted other expenses for the quarter ended Dec. 31 were up roughly $26 million compared with a year earlier. “This increase in expense was primarily due to increased pension expenses, which were a result of higher interest rates,” interim CFO Neil Russell told analysts on a Jan. 31 earnings call.
Sysco in the quarter incurred a noncash charge of $315 million stemming from transferring nearly $700 million of its U.S. pension liabilities to an insurer.
The increased costs will in the long run balance out for plan sponsors because the aggregate pension costs expensed will equal the benefits paid out, minus investment returns, Mercer’s Mr. McDaniel said. But long term in pension terms is 50 years or 70 years, he said. “So it’s not like you can say, ‘Well, OK, it’s off this year and everything will drop back to normal next year.’ Those higher costs can persist.”