New York, June 15, 2006
The funded status of pension plans - the ratio of plan assets to liabilities - at major US companies held steady in 2005 at 83% following two years of modest improvement, according to a new analysis by Mercer Human Resource Consulting and Mercer Investment Consulting. However, the impact of "mark to market" balance sheet accounting will be reduced shareholder equity and greater reported volatility, assuming that proposed pension and retiree medical accounting changes go into effect later this year.
In the report How does your retirement program stack up?,Mercer analyzed retirement plan data disclosed by the S&P 500 companies in their 10-K reports for the 2005 fiscal year. The analysis enables companies to compare their pension costs with competitor peer groups or with companies in the same industry group, permitting them to better understand how pension costs affect their company´s overall cost structure, risk profile and competitive position.
"Many pension plan sponsors continue to sail on treacherous seas," said Frank Todisco, a senior consultant and actuary with Mercer Human Resource Consulting. "The devastating effects of the ´perfect storm´ of 2000-2002 - when negative equity returns combined with falling interest rates - are still being felt. Pension expense held steady at 0.5% of revenue from 2004 to 2005, artificially sustained by the continued recognition, in current expense, of equity and discount rate losses that occurred several years ago. And now proposed pension accounting rules requiring that plan assets and liabilities - for retiree medical in addition to pension benefits - be ‛marked to market´ will produce greater volatility in companies´ financial reports."
A pension plan´s funded status is affected by its investment returns and the net percentage increase in its liabilities (after adjusting for new benefit accruals, employer contributions and any plan amendments or curtailments). (See Exhibit 1.) Among the S&P 500 companies studied, investment returns slowed to single digits during 2005 - 8.2% at the median - and are off to a weak start in 2006. Mercer Investment Consulting estimates that the return for a typical plan during the first five months of 2006 was 5.6% on an annualized basis. By comparison, the median investment returns in 2004 and 2003 were 12.4% and 18.1%, respectively.
In contrast, the rise in interest rates in the first five months of 2006 represents a dramatic turnaround from the long, steady decline of the prior three years, with a significant positive impact on funded status. In the first five months of 2006, Mercer found, the discount rate on sample plans it analyzed rose 75 basis points. Combined with the 2006 investment returns cited above, the effect would have been to raise the funded status of the median plan analyzed from 83% to 93%.
New pension accounting rules would hurt shareholder equity
Earlier this year, the Financial Accounting Standards Board (FASB) issued an exposure draft that would require plan sponsors to reflect the net funded status of their pension and postretirement medical and life insurance plans directly on the balance sheet. FASB will hold a public roundtable this month to hear from users, preparers and analysts, and has said it will issue its final standard in late September.
Mercer found that if the accounting change had been in effect during the 2004 and 2005 fiscal years, many S&P 500 companies would have experienced a significant reduction in shareholder equity. Overall, the median reduction in reported shareholder equity would have been nearly 3%, assuming a 35% tax rate. (See Exhibit 2.)
But for many companies the effect would have been greater. One-fourth of the plans would have experienced a reduction in company shareholder equity of 8% or more. One-tenth would have seen shareholder equity reduced 18% or more, and handful would have had shareholder equity wiped out as a result of the accounting change.
Freezing the pension plan
While Mercer expects additional companies to freeze their plans or close them to new entrants, it is important to note that a substantial majority of S&P 500 plan sponsors have not taken such action.
"The stability of pension plan operational expense through the end of 2005 suggests that, so far, the headline-grabbing phenomena of plan freezes and benefit-formula reductions, while unquestionably important, have been the exception rather than the rule," said Mr. Todisco.
However, almost all companies are evaluating their overall retirement program philosophy, according to Mr. Todisco, including their attitudes toward bearing risk and sharing risk with employees, the appropriate mix of DB (defined benefit) and DC (defined contribution) approaches and the affordable level of benefits.
About the study
Mercer based its analysis primarily on information contained in the 10-K reports filed by 488 companies in the S&P 500 for the 2005 fiscal year. The study provides benchmarking data against which pension plan sponsors can compare their plans´ performance. Among these 488 companies, some 370 reported some information on defined benefit (DB) plan liabilities. The survey also collected data on defined contribution (DC) and retiree medical and life insurance plans.
An executive summary of the report How does your retirement program stack up? is available online at www.mercerhr.com/referencecontent.jhtml?idContent=1183660. The full report will be available this summer.
About Mercer Human Resource Consulting and Mercer Investment Consulting
Mercer consults with plan sponsors in the areas of plan benefit design, funding policy, accounting options and investment policy, to help them provide optimal benefits to employees while controlling costs and, particularly, managing risk. Mercer has helped clients develop plan designs, funding strategies and investment policies to balance human resource objectives with financial constraints while minimizing the chances of spikes in expense, contributions, or accounting liability.
Mercer Human Resource Consulting is a global leader for HR and related financial advice and services, with more than 15,000 employees serving clients in more than 190 cities and 40 countries and territories worldwide.
Mercer Investment Consulting is a leading global provider of investment consulting services and offers customized guidance at every stage of the investment decision, risk management and investment monitoring process. It has been dedicated to meeting the needs of clients for more than 30 years, and works with the fiduciaries of pension funds, foundations, endowments and other investors in some 35 countries. Mercer Investment Consulting is a unit of Mercer Human Resource Consulting, an operating company of Marsh & McLennan Companies, Inc. (MMC). MMC lists its stock (ticker symbol: MMC) on the New York, Chicago, Pacific and London stock exchanges.