Deficits in US pension plans approach record high

The deficit in pension plans sponsored by S&P1500 companies reached $451 billion at the end of June, just $1 billion short of the previous record high set in mid-January 2009, according to new figures from Mercer[1]. Mercer’s figures also show that the increase in the deficit of $115 billion during June, caused by concurrently falling interest rates and equity values, was the third largest increase of the past decade[2].  The end of June deficit corresponds to a funded status of 73% compared to 78% at the end of May. The 2009 year-end deficit was $247 billion, corresponding to a funded status of 84%.

 

“On average plan sponsors still have a majority of their assets invested in equities, so the 5.4% fall in equity values over the last month has adversely affected plan assets. Additionally, AA bond yields have also declined by about 40 basis points since the end of May increasing the value of plan liabilities. The combined effect of the fall in equity values and the fall in AA bond yields is a five percentage point decline in funded status, and may come a surprise to many plan sponsors” said Adrian Hartshorn, a partner in Mercer’s Financial Strategy Group.

 

This current downturn in pension health measures effectively erases gains achieved since January 2009, including $75 billion of contributions paid by plan sponsors in 2009[3]. Relatively large changes in funded status, similar to those that have occurred in the past month, are more likely when there is a significant mismatch in the asset-liability investment strategy of a pension plan. In particular, changes in the value of equities are largely uncorrelated with changes in the value of plan liabilities, so that a plan sponsor with a material pension plan investment allocation to equities can expect funded status and cash contribution requirements to be volatile.

 

Larger pension deficits will translate into larger required pension contributions in 2011 for most plans under the funding rules of the Pension Protection Act. However, limited pension funding relief was passed by Congress and signed by the President in June. This legislation will result in somewhat lower contribution requirements over the next several years as it permits deferral or extended amortization of losses experienced during 2009 – 2011. While this relief is welcome news, plan sponsors should continue to evaluate the impact of the recent funded status losses on their investment and contribution policies.

 

“We expect more plan sponsors to consider the impact their pension plan has on their underlying business and consider ways in which risk can be managed. This is likely to involve forecasting the impact of the latest funded status downturn on future contribution and pension expense along with other business metrics. Sponsors that choose to reduce risk need to consider the tension that exists between higher ongoing cost and lower volatility. These will be tough decisions and there is no easy solution, “said Mr. Hartshorn.

 

“However, we are aware of a number of plan sponsors who have resolved this issue and have implemented solutions. Those that have been publicized and are in the public domain have generally been well received by the investor community, “said Mr. Hartshorn.

 

Mercer estimates the aggregate combined funded status position of plans operated by S&P 1500 companies on a monthly basis. Figure 1 shows the estimated aggregate surplus/deficit position and the funded status of all plans operated by companies in the S&P 1500. This is based on projections of their reported financial statements[4] adjusted from each company’s financial year end to June 30 in line with financial indices. This includes US domestic qualified and non-qualified plans and all non-domestic plans. The estimated aggregate value of pension plan assets of the S&P 1500 companies at December 31, 2009, was $1.25 trillion, compared with estimated aggregate liabilities of $1.50 trillion. Allowing for changes in financial markets though the end of June 2010, changes to the S&P 1500 constituents, and newly released financial disclosures, the estimated aggregate assets were $1.23 trillion, compared with the estimated value of the aggregate liabilities of $1.68 trillion.

 

Unless otherwise stated, the calculations are based on the Financial Accounting Standard (FAS) funding position and include analysis of the S&P 1500 companies.

 

Information on the Mercer Yield Curve is available at: www.mercer.com/pensiondiscount.

 

Mercer is a leading global provider of consulting, outsourcing and investment services. Mercer works with clients to solve their most complex benefit and human capital issues, designing and helping manage health, retirement and other benefits. It is a leader in benefit outsourcing. Mercer’s investment services include investment consulting and multi-manager investment management. Mercer’s 18,000 employees are based in more than 40 countries. The company is a wholly owned subsidiary of Marsh & McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on the New York, Chicago and London stock exchanges. For more information, visit www.mercer.com.

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