The Markets August 21, 2014

Industries Have Differing Tolerances for Pension Investing Risk

Financial services, energy and consumer staples have the best-funded defined benefit plans, according to an analysis by the BNY Mellon Investment Strategy and Solutions Group (ISSG).
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The analysis of the defined benefit plans of 931 public companies revealed information technology (IT) and health care companies tend to have the lowest-funded plans. IT companies posted an average funded status of approximately 77%, while the health care sector had an average funded status of approximately 82%.

Financial services firms, which had an average funded status of approximately 94%, also as a group had the lowest requirement to fund their plans, according to ISSG. Companies in financial services tended to have higher-than-average allocations to equities, while well-funded plans in other business sectors had higher allocations to fixed income and liability driven investing (LDI) strategies. 

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“While financial services companies may be in a better position than most sectors to adopt a de-risking strategy, many have elected to be aggressively invested,” says Andrew D. Wozniak, head of fiduciary solutions, ISSG. “They can do this as they have the best ability to take on risk, particularly as their defined benefit pension plans are relatively small compared to the size of the companies in the sector.”

Different companies have varying abilities to take on risk, such as allocating a higher portion of their plan assets to more aggressive and volatile asset classes, ISSG explains. The ability to take on risk is based on three key factors:

  • The size of the pension plan compared to the size of the company;
  • Cash that must be contributed to pension plans compared to free cash flow; and
  • Pension expense compared to operating income.

Considering these factors, ISSG notes that utilities, materials and telecommunications companies have the least ability of the companies that were part of the analysis to take on risk within their pension plans. “It is important for these companies to undergo periodic stress testing to determine how they would weather a deflationary environment,” Wozniak says. “In a deflationary environment, interest rates and equity values tend to fall, causing plan funded status to diminish. Companies with a limited ability to take on risk will need to make sure they have enough cash on hand.”

According to Wozniak: “In analyzing risk tolerance, BNY Mellon recommends plan managers take an enterprise risk management (ERM) approach. This means evaluating opportunities and risk from the lens of the entire corporation, rather than viewing the pension plan in isolation. By helping plans view their risks and opportunities from an ERM approach, we can help them avoid threats that plans taking only a narrow approach could miss.”

The analysis was based on an analysis of 931 public companies, which were broken down into the following sectors: Consumer Discretionary (117), Consumer Staples (67), Energy (57), Financials (164), Health Care (60), Industrials (199), IT (76), Materials (108), Telecomm (10) and Utilities (73). Funded status for each sector was determined by first calculating the funded status (fair value of plan assets/projected benefit obligation) for each company within the sector with and then taking the median of these values. The bottom and top 2.5% of values were excluded. The information used for the analysis comes from publicly available sources that have not been independently verified.

Diversions August 21, 2014

Child Rearing Costs Could Hit a Quarter Million

A child born in 2013 can cost his parents about $245,340 for food, housing, child care, education and other child-rearing expenses by the time he hits 18.
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And that amount is more like $304,480 when adjusted for projected inflation, says the U.S. Department of Agriculture’s annual analysis of average family expenditures on children. The figures are meant to reflect the expenses and lifestyle of a middle-income family.

According to the survey results, which are published annually as the “Cost of Raising a Child” report, the cost represents an overall 1.8% increase from 2012, though percentages spent on each expenditure category remain the same.

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As in the past, the costs by location are lower in the urban South ($230,610) and rural ($193,590) regions of the country. Families in the urban Northeast incurred the highest costs to raise a child ($282,480).

For the year 2013, annual child-rearing expenses per child for a middle-income, two-parent family ranged from $12,800 to $14,970, depending on the age of the child. The report also notes that family income affects child-rearing costs. A family earning less than $61,530 per year can expect to spend a total of $176,550 (in 2013 dollars) on a child from birth up to age 18. Parents with an income between $61,530 and $106,540 can expect to spend $245,340; a family earning more than $106,540 can expect to spend $407,820 on raising a child.

For middle-income families, housing costs are the single largest expenditure on a child, averaging 30% of the total cost. Child care and education was the second-largest expense, at 18%, followed by food, which accounted for 16% of the total cost.

The average cost of housing for a child up to age 18 is $87,840 for a middle-income family in the urban West, compared with $66,240 in the urban South and $70,200 in the urban Midwest.

In 1960, the first year the report was issued, a middle-income family could have expected to spend $25,230 ($198,560 in 2013 dollars) to raise a child until the age of 18. Housing was the largest child-rearing expense both then and now. Health-care expenses for a child have doubled as a percentage of total child-rearing costs during that time. In addition, some common current-day costs, such as child care, were negligible in 1960.

Expenses per child decrease as a family has more children. Families with three or more children spend 22% less per child than families with two children.

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