The aggregate deficit in U.S. defined benefit pension plans sponsored by S&P 1500 companies reached $484 billion as of Dec. 31, 2011, an increase of $169 billion from year-end 2010, according to figures from HR consultancy Mercer. This deficit corresponds to an aggregate funded ratio of 75 percent as of Dec. 31, 2011, vs. a funded ratio of 81 percent as of Dec. 31, 2010.
Mercer attributes the drop in funded status in 2011 primarily to a decrease in discount rates (based on the current yield for high-quality, long-term corporate bonds) during the year. As discount rates decrease, liabilities increase.
On the asset side, U.S. equity markets were up approximately 1 percent for the year, and there were strong returns on U.S. fixed income (bonds), with double-digit returns for long maturity bonds. As a bond's yield falls, its price rises. However, with less than 45 percent of pension plan assets generally invested in fixed income and often in shorter maturity bonds, these positive bond returns had a small impact on overall funded status.
“With U.S. and non-U.S. equity indices underperforming expectations and interest rates on high-quality corporate bonds declining upwards of 100 basis points, driving discount rates down and plan liabilities up significantly, we saw a marked decline in funded status,” explained Jonathan Barry, a partner with Mercer’s retirement risk and finance consulting group. “We also saw wide fluctuations in funded status throughout 2011—with the aggregate funded status peaking at about 88 percent at the end of April and hitting a low of 71 percent at the end of September—the largest month-end deficit we have ever seen since we began tracking this information.”
Pension Contributions Up
The funded status deficit would have been worse if not for the estimated $50 billion that companies disclosed they expected to contribute during 2011. “Many plan sponsors are merely treading water or even moving backwards on funded status despite significant cash contributions to their plans,” said Barry. “For many companies, the larger deficit will drive higher profit and loss expense as well as large increases in pension funding requirements for 2012.”
Increasing pension deficits are a major concern for many pension plan sponsors because of the negative impact on reported earnings and free cash flow. “Management has a better use for these funds, whether increasing dividends to shareholders or making business investments to increase competitiveness and potentially support job creation,” Barry noted.
Continued funded status volatility is another concern. “We see a growing number of pension plan sponsors seeking to reduce the effect of pension volatility on their balance sheets and cash funding requirements,” said Kevin Armant, a principal with Mercer’s financial strategy group. “Dynamic asset allocation approaches that systematically reduce volatility as funded status improves are gaining traction, and many plan sponsors are engaged in detailed planning around the logistics of making lump-sum cash-outs available to terminated participants as a means of reducing liabilities. We are also seeing more interest in exploring insurer buy-outs as a means of eliminating liabilities.”
Armant’s comments are borne out by a late 2011 survey of senior-level financial executives conducted by Mercer and CFO Research Services. Roughly half the surveyed plan sponsors said they were at least somewhat likely to match fixed income duration to their plan liabilities and increase their fixed-income allocations.
“We see plan sponsors positioning themselves for when funded status improves—from the impact of rising interest rates, strong equity market returns or additional funding—and we expect there will be a significant shift from equities to bonds once that occurs,” said Nick Davies, a Washington, D.C.-based principal in Mercer’s investments business. “Corporate defined benefit plan sponsors are intently focused on risk management issues, and many are poised to make significant changes. The open questions are, how quickly will market changes occur and do sponsors have the conviction and capability to carry out their intended changes?”
Mercer estimates the aggregate combined funded status of plans operated by S&P 1500 companies on a monthly basis. The figure below shows the estimated aggregate surplus or (deficit) position and the funded status of all plans operated by companies in the S&P 1500 from the end of 2007 through the end of 2011.
Lower Rates Sent Liabilities Higher at Year End
Another report on the status of U.S. pensions reaches similar conclusions.
A sharp bounce in liabilities in December 2011 resulted in a 2.7 percentage point decrease in the funded status of the typical U.S. corporate pension plan, according to BNY Mellon Asset Management. For the year, the funded status declined 12.7 percentage points to 72.4 percent, according to the BNY Mellon's Pension Summary Report for December 2011.
The decline in funded status was the second biggest calendar year decline since BNY Mellon began tracking this data in 2005. The large decline in 2011 was due to the liability discount rate reaching a new historic low, 4.36 percent, surpassing the record set in September 2011, according to the report. BNY Mellon noted that assets for the typical plan did increase 2.7 percent in 2011, but liabilities increased much faster, 20 percent, to send funding levels lower for the year.
"The continuing uncertainty regarding the prospects for a U.S. economic recovery and the ongoing European debt crisis drove investors back into bonds during December, which sent interest rates lower," said Jeffrey B. Saef, managing director, BNY Mellon Asset Management, and head of the Investment Strategy & Solutions Group (a division of The Bank of New York Mellon). "We expect continuing volatility until investors believe the recovery in the U.S. is sustainable and some resolution is reached in Europe."
Milliman Analysis: Bad Year for Pensions Ends Badly
In Januyar 2012, Milliman Inc., a global consulting and actuarial firm, released the results of its Milliman 100 Pension Funding Index, which covers 100 of the largest defined benefit pension plans in the U.S. December 2011 cemented a bad year, which left these 100 pensions with a $236.4 billion increased deficit as corporate pensions faced record underfunding.
"This was an unusually dispiriting year for these 100 pensions," said John Ehrhardt, co-author of the Milliman Pension Funding study. "Assets treaded water this year, producing an anemic $12.3 billion increase in value as record-low interest rates increased pension liabilities by $248.7 billion.
While 2011 was a bad year, the year-end 72.4 percent funded ratio for the Milliman 100 Pension Funding Index still could not eclipse the record of 70.5 percent set in May 2003.
Stephen Miller, CEBS, is an online editor/manager for SHRM.
Transitioning from Defined Benefit to Defined Contribution Retirement Plans, SHRM Online Benefits Discipline, January 2012
CFO Survey: Continued Volatility Will Alter Pension Risk Management, SHRM Online Benefits Discipline, December 2011
Risk-Management Q&As for HR Professionals Who Oversee Pension Plans, SHRM Online Benefits Discipline, November 2011
Underfunding of Liabilities Seen as Top Pension Risk, SHRM Online Benefits Discipline, November 2011
Pension Funding Hits Post-World War II Low, SHRM Online Benefits Discipline, October 2011
Six Ways to Reduce Pension Costs and Volatility, SHRM Online Benefits Discipline, October 2011
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