U.S. pension plan funded positions fell to historic lows during August 2010 because of the confluence of falling equity markets and interest rates, according to Mercer, an HR consulting firm.
The deficit in pension plans sponsored by S&P 1500 companies increased by $76 billion to $506 billion at the end of August 2010, according to Mercer's figures. This pension plan shortfall is the largest ever recorded by S&P 1500 companies and is more than double their 2009 year-end deficit of $247 billion.
The end-of-August deficit corresponds to a funded status of 71 percent, compared to a funded status of 84 percent on Dec. 31, 2009.
“If the low-funded status persists until the end of 2010, net balance sheet liabilities and income statement expense for 2011 will increase significantly for many companies. Cash contributions will need to increase to reduce the deficit,” said Gordon Young, the integrated retirement financial management leader for Mercer in the U.S. “Some of this may be mitigated by various smoothing methods and pension funding relief, but nonetheless these market conditions will certainly grab the attention of plan sponsors,” he observed.
“Cash contributions will need to increase
to reduce the deficit.”
For most of 2010, equity values have experienced significant volatility. For example, equity returns were up 7 percent in July and down 5 percent in August 2010. In addition, concerns remain over the yield level of AA-rated bonds, which declined steadily declining in 2010—reaching 4.94 percent at the end of August 2010, the lowest yield in a decade. Because pension plan liabilities are valued using the AA bond yield, these lower yields translate into higher plan liabilities.
“The last several months have reminded us that financial risk is inherent in pension plans. Increasing deficits caused by volatility in both the equity and bond markets highlights the inherent risk in the investment strategies being pursued by many companies," Young said. "Plan sponsors should understand that they need a sound plan to measure and manage this risk. In the absence of sound risk management, plan sponsors will experience recurring episodes of financial pain and temporary relief in their pension plan due to market fluctuation,” he warned.
Relatively large swings in the funded status of pension plans can occur when there is a significant mismatch between the way that assets are invested and the way that liabilities are valued. For example, changes in the value of equities largely are uncorrelated with changes in the value of liabilities, so a plan sponsor with a material pension plan investment allocation to equities can expect funded status and cash contribution requirements to be volatile.
“Over the past several years there has been an increasing trend to implement investment strategies that result in higher correlation between how assets and liabilities behave, thus hedging more of the funded status risk," said Mick Moloney, senior partner and global leader of Mercer’s financial strategy group. "We think this trend will only accelerate given the current market conditions. Also, we believe that, increasingly, plan sponsors, especially those with mature plans, will be seeking to implement specific strategies to dynamically reduce pension plan financial risk over time,” he added.
Mercer estimates the aggregate combined funded status position of plans operated by S&P 1500 companies on a monthly basis. The figure below shows the estimated aggregate surplus/deficit position and the funded status of all plans operated by companies in the S&P 1500.
Stephen Miller is an online editor/manager for SHRM.
Young Workers Concerned About Keeping Defined Benefit Plans, SHRM Online Benefits Discipline, September 2010
Pension Funding Relief Could Reduce Required Contributions, SHRM Online Benefits Discipline, August 2010
Market Volatility Leads to Broader View of Pension Risks, SHRM Online Benefits Discipline, March 2010
SHRM Online Benefits Discipline