Companies that operate traditional pension plans felt the pinch last year when low interest rates combined with mediocre equity returns to erode plan funding. That pinch is likely to continue this year. SEI, an asset management and investment processing company, predicts plan sponsors will lower the discount rate they use to measure their future liabilities, a move that means many will end up needing to contribute more to their plans.
A recent study by SEI suggests that in the coming year, plan sponsors will use discount rates that are 70 to 85 basis points lower than last year’s. The discount rate is used to measure a defined-benefit pension plan’s future liabilities.
Jon Waite, director of investment management advice and chief actuary of the institutional group at Oaks, Pa.-based SEI, says the change in plan sponsors’ discount rates reflects the change in bond yields in the past year. “We saw yield curves overall drop about 50 basis points, and what we’re seeing is that’s following through on the various rates they’re selecting.”
Pension plan discount rates were “significantly low” even before the latest decrease, Waite says. “As discount rates in general come down, we’re going to see contribution requirements increase,” he adds.
The discount rate for pension plans is typically tied to the yield on AA-rated corporate bonds. But SEI suggests that companies come up with a discount rate by calculating their pension plan’s future obligations and looking at the yields at matching points on the yield curve, rather than just adopting a single rate from a bond index. That method could mean more variance in the discount rates used by various plan sponsors, Waite says.
In fact, though, the range of discount rates is narrowing. The SEI study shows that in 2010, discount rates ranged from 4.80% to 6.20%, a 140-basis-point range that was 21 basis points narrower than the range in 2009.
The SEI study also shows that relatively few plan sponsors adjusted their assumption about the return on their plan assets, despite the market volatility in recent years. In 2010, 45% of plan sponsors left their return on assets assumptions unchanged, while 17% increased their assumptions and 38% decreased their assumption.
The majority (59%) of the 686 plan sponsors studied had return-on-asset assumptions between 7.50% and 8.50%, and 90% had return-on-asset assumptions between 5.36% and 8.66%.
Mercer, the human resources consulting company, estimates that the aggregate funded ratio of the pension plans of S&P 1500 companies declined to 75% at the end of 2011 from 81% at the end of 2010. Mercer calculates that S&P 1500 companies with traditional pension plans have an aggregate plan deficit of $484 billion as of yearend 2011, up $169 billion from yearend 2011, even though companies made an estimated $50 billion in contributions to their plans last year.
For more on the outlook on pension funding, see Plan Sponsors Face a Decade of Rising Contributions.