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Biggest U.S. Pensions Lost Ground; More Interest in Hybrids
In 2010, corporate pensions saw late recovery from 10-year low in funded status; cash balance plans staged a comeback

By Stephen Miller  1/14/2011

The average funded status of the 100 largest U.S. defined benefit pension plans fell to 79.8 percent at the end of 2010, down from 81.9 percent at year-end 2009, according to consulting and actuarial firm Milliman Inc.

Plans in the Milliman 100 Pension Funding Index increased the value of their assets by $50 billion in 2010 but saw their liabilities increase by $99 billion, leaving them an additional $49 billion in the hole.

"The year started strong, but then came the massive liability increases of the summer, which took us to a 10-year low in pension funded status," said John Ehrhardt, co-author of the Milliman 100 Pension Funding Index. "A market rally and generally positive interest rate performance since August helped make up for that all-time low but it wasn't enough to counteract the ballooning pension obligation. Looking to 2011, these 100 plans sponsors face an estimated $4 billion in additional pension expense."

If interest rates continue along their current lines and the largest 100 pensions achieve their 8.1 percent median return, the funding deficit would persist into 2012, according to Milliman. An optimistic forecast—6.52 percent interest rates by the end of 2012 and 12.1 percent annual returns—would help the pension funded status recover to 107 percent by the end of 2012.

Another View
A broader analysis by Aon Hewitt reported that the funded status of pensions sponsored by U.S. companies in the S&P 500 to be at a somewhat healthier 88 percent at the close of 2010, with no change from the start of the year. "Albeit, the year was marked by three quarters of positive asset returns, which offset the negative returns of the second quarter and also negated the drop in interest rates," Aon Hewitt noted.

The firm's analysis found that globally the funded status of pension plans was at 87 percent at year-end 2010, up slightly from 86 percent at the beginning of the year.

“As we look to 2011 and beyond, organizations will increasingly strive for balance between funding and investment strategies in dealing with pension deficits,” explained Ari Jacobs, Aon Hewitt’s retirement solutions leader. “Many employers will consider risk management programs that combine de-risking plan investments with strategic funding.”

Renewed Interest in Cash Balance Plans

Cash balance "hybrid" pension plans, where employees stand to get a lump-sum payment at retirement based on a system of credits, are poised to gain traction in 2011, according to consultancy Towers Watson.

In 2006, the Pension Protection Act acknowledged the legitimacy of hybrid defined benefit plans. In October 2010 the IRS proposed rules to provide more clarity on the plans (see the SHRM Online article "Proposed IRS Rules Expand Options for Cash Balance Plans"). The rules are expected to lower the interest credit rate that companies use when determining interest credits on cash balance accounts. That could decrease the amount that some existing cash balance plans need to contribute—making them more attractive to sponsoring companies, according to Towers Watson's report, Hybrid Pension Plans: A Comprehensive Look at Their History, Economics and Features.

“Once finalized, these rules eliminate virtually all of the uncertainty that has surrounded cash balance plans the past few years,” said Alan Glickstein, senior consultant at Towers Watson. “Many employers have been waiting for these rules before adopting a new retirement plan design. With this clarification of legal requirements and the resolution of lingering ambiguities, more plan sponsors may be encouraged to convert their traditional defined pension plans to hybrid plans.”

The Comeback

About one-fourth (24 percent) of the Fortune 100 companies offered a hybrid pension plan in 2009, up from just eight companies in 1998, according to Towers Watson.

The firm noted that the cost and cash contribution for credits to a cash balance plan are generally less than those for the same final retirement benefit in a defined contribution plan.

The 2008-09 recession "shows the attractive risk-sharing and cost management features of hybrid plans to greater advantage, especially given the consequent high contributions and funding volatility in traditional defined benefit plans and the significant asset losses to many defined contribution accounts," said Kevin Wagner, senior consultant at Towers Watson. "Hybrids’ mix of cost-effective defined benefit and defined contribution features can be very appealing to employers, while most workers welcome their reliability and security,” he added.

Greater Retirement Certainty

A large majority of U.S. workers say they are willing to pay more now for greater certainty in their future retirement benefits, Towers Watson's research shows. Additionally, the number of younger workers who cite their pension plans as an important reason to work for their current employer jumped by more than half in 2010—from 28 percent in 2009 to 43 percent in 2010.

Other findings from the Hybrid Pension Plans study include:

Approximately one-third of all active participants and assets in U.S. defined benefit plans were associated with hybrid plans.

Between 1999 and 2007, the number of participants in hybrid plans increased from 3.2 million to 10.2 million, and assets increased from $158.8 billion to $631 billion.

After 30 years of service, the average worker in a cash balance plan will have, on average, an account balance of between two and two and a half times their final salary, depending on the benefit formula.

Stephen Miller is an online editor/manager for SHRM.

Related Articles:

Proposed IRS Rules Expand Options for Cash Balance Plans, SHRM Online Benefits Discipline, November 2010

Pension Volatility: How to React as Funding-Level Forecasts Spike and Fall, SHRM Online Benefits Discipline, November 2010

Market Volatility Leads to Broader View of Pension Risks, SHRM Online Benefits Discipline, March 2010

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