Having seen some recovery from the 2008 year-end lows, the funded status of large U.S. defined benefit pension plans fell again in July 2009 for the third consecutive month, according to the latest estimates. Although equity (stock) values are increasing, so is the value of plan liabilities — caused by falling yields on corporate bonds — so that the net impact in July was a decline in the funded status.
According to analysis by HR consultancy Mercer, the funded status of pension plans sponsored by S&P 1500 companies deteriorated by $34 billion during the month of July 2009, bringing the aggregate funded status to 81 percent as of July 31, down from 82 percent at June 30. The 2008 year-end funded status was 75 percent.
“There was a strong positive return from equities of 7.4 percent during July. This helped increase the estimated aggregate value of assets of pension plans sponsored by S&P 1500 companies by 6.2 percent," said Adrian Hartshorn, a member of Mercer’s Financial Strategy Group. "However, falling yields on AA corporate bonds (from 6.79 percent to 6.10 percent in July) means that the liability values of pension plans for the same companies increased by 7.6 percent. Companies should focus attention on the return relative to the liabilities, which was negative 1.3 percent,” Hartshorn added.
Similarly, in July 2009, the Milliman 100 Pension Funding Index, tracking the largest 100 U.S. corporate defined benefit pension plans, experienced asset increases of $31 billion but liability increases of roughly $46 billion, resulting in a $15 billion decrease in funded status. The decline reduced funded status to 75.4 percent, based on $992 billion in assets and a projected benefit obligation of $1.316 trillion.
“Based on asset activity it seems like July should have been a good month,” said John Ehrhardt, a Milliman principal and consulting actuary. “But instead we’re losing ground because of declining interest rates. At this pace, getting back to a mere 80 percent funded status by the end of the year is going to require both favorable interest rate movement and better than 20 percent return on assets.”
Over the 12 months prior to July 2009, the cumulative asset return has been -10.85 percent and the funded status has fallen by $333 billion. For these 12 months, the funded ratio of the Milliman 100 companies has fallen from 100.8% to 75.4%.
What to Expect for the Rest of 2009
With an expected return of 8.1 percent and a discount rate of 5.57 percent for the balance of 2009, the funded status of the Milliman 100 pension plans is projected to slightly increase, with an expected pension deficit of $319 billion and a funded ratio of 75.9 percent as of year-end.
“As companies set budgets and business plans for 2010, the potential impact of the 2008 investment performance will continue to be important," said Mercer's Hartshorn. "Under U.S. Financial Accounting Standards Board pension accounting rules (FAS 87) and U.S. funding rules (set out in the Pension Protection Act), the effect of reductions in funded status on earnings and cash contributions can be smoothed or deferred. In the absence of a sharp recovery in the pension plan funded status before the end of the year, many companies could be facing higher pension costs under FAS 87 and higher cash contribution requirements in 2010 compared to 2009.”
Additionally, he noted, “the smoothing and deferral mechanisms permitted under FAS and PPA can cause a disconnect between pension plan accounting, pension plan funding and what is really happening to the pension plan. In particular, an underfunded pension plan will need additional funding from future cash flows of the business either now or in the future, leaving less available for capital investment and dividend payments to shareholders.”
Pension Plan Freezes Continue at Steady Pace, SHRM Online Benefits Discipline, July 2009
Bond Markets Deal Fresh Blow to Underfunded Pensions, SHRM Online Benefits Discipline, July 2009
Liability-Driven Investing Strategies Proved Worth, SHRM Online Benefits Discipline, February 2009
Pension Funds Slash Expectations for Investment Returns, SHRM Online Benefits Discipline, February 2009
Countering Pension Risk Myopia, SHRM Online Benefits Discipline, February 2009
Pension Plan Deficits Hit Record; Many Revisit Funding Strategies, SHRM Online Benefits Discipline, January 2009
Stephen Miller is an online editor/manager for SHRM.
SHRM Online Benefits Discipline