U.S. defined benefit plans, which sharply improved their funding status in 2013, gave up most of those gains in 2014, according an analysis of pension plan data at 411 of the Fortune 1000 companies completed recently by Towers Watson.
February 27, 2015
By Robert Stowe England
When it comes to restoring funding levels lost in the financial crisis, U.S. corporate pension plans seem to be on a treadmill going nowhere.
In 2012, the funding level for U.S. corporate plans stood at 77 percent. Funding then rose sharply to 89 percent in 2013 as market returns soared, giving the plans their best funding status since before the recession. During 2014, however, plans gave up 9 percentage points, as funding levels fell to 80 percent, according to Towers Watson.
The stumble in funding status in the current cycle is a big disappointment for struggling pension plans and may call for diminished expectations for a full recovery, according to Alan Glickstein, a senior retirement consultant at Towers Watson in Dallas.
In the past plans were able to fully recover, according to Glickstein. For example, after funding fell sharply in 2002, from 101 percent to 82 percent, plans “clawed their way back” to 99 percent 2006 and 106 percent in 2007, he says. However, in the current ongoing cycle that began after a big drop in funding to 77 percent in 2008, “we’re not clawing our back,” to full funding, Glickstein says. “We’re just circling the drain here at the 80 percent level.”
“Maybe there’s a new normal here,” says Glickstein, where the funding gap is not closed unless and until there are higher interest rates – the key factor that caused funding levels to plummet in 2014. When interest rates are low, under rules governing how a plan’s pension benefit obligation is calculated by actuaries, plans have to assume current assets will earn less in the future.
The funding status of a plan is a ratio of the current value of assets held by a plan as a share of the present value of the plan’s future pension obligations. The ratio is based on a calculation of how much the plan will pay out to current workers and retirees in the future. If a plan is fully funded, its funding level is 100 percent and it can meet all its future obligations for current workers and retirees.
During 2014, a lower discount rate caused most of the slide in funding. The discount rate is the interest rate used to calculate the future returns on a plan’s investment assets. Since 2007, the average discount rate has declined every year except for 2013. While the average discount rate was 6.29 percent in 2008, it slide to 3.95 percent in 2012, then rose to 4.78 percent in 2013 – giving plan funding a good boost. In 2014, however, Towers Watson the plans in its analysis will use an average discount rate of 3.90 percent, lowest rate so far in the current cycle.
Towers Watson calculates that the plans in its analysis had a $1.520 trillion pension benefit obligation in 2013, rising to $1.746 trillion in 2014 – a significant 15 percent increase in liabilities. At the same time, plan assets are estimated to have increased a modest 3.27 percent from $1.358 trillion in 2013 to $1.402 trillion in 2014.
Plans had another setback in their funding calculations in 2014, as they prepared to incorporate one-time longevity improvements for workers and retirees. Watson Towers estimates that revised mortality assumptions represent the second largest factor driving down the funding level of plans, representing 40 percent of the overall 9 percent decline in funding levels, according to Glickstein.
Last October the Society of Actuaries’ Retirement Plans Experience Committee released its final report for the Mortality Improvement Scale, known as MP-2014, and its Mortality Tables Report, RP-2014. Under the new mortality tables, a 65 year-old male has improved his lifespan by 4.5 percent over the 2000 tables, while a 65-year-old female has gained 5.8 percent in her expected life span.
If the IRS adopts the Society of Actuaries 2014 mortality tables for reporting requirements for plans, it would increase the average lump sum payout for a 55 year old by 5.1 percent, assuming an equal amount of men and women in the workforce, according to October Three, a Chicago consulting firm.
The pension benefit obligation also incorporates future expected contributions from the corporate sponsor to their pension plan for employees. Relying on publicly released information in annual company 10-K filings with the U.S. Securities and Exchange Commission, Towers Watson estimates that companies contributed $30 billion to their plans in 2014 – even though many of them have been closed to new hires.
“Unless there is an uptick in interest rates or equity market performance, this year will most likely bring higher expense charges and additional contribution requirements,” says Dave Suchsland, a senior retirement consultant at Towers Watson in Lafayette Hill, Pennsylvania.