From the September/October 2012 issue of Treasury & Risk magazine

Pensions Under Stress

The funding of defined-benefit pension plans has eroded still more this year amid record-low levels of interest rates.

The funded status of defined-benefit pensions has deteriorated again so far this year, leaving companies with quite a hole to climb out and suggesting more plan sponsors will freeze or close their plans. “2012 so far has been a difficult year for pension plan sponsors,” says Jonathan Barry, who leads Mercer’s defined-benefit risk consulting efforts for its U.S. retirement risk and finance business. “Even though we’ve had decent equity returns for the year, interest rates have dropped so much that the majority of U.S. pension funds’ funded status has declined.”

Mercer calculated the aggre-gate deficit of plans operated by S&P 1500 companies totaled $689 billion at the end of July, up $200 billion from the shortfall at the end of last year. It estimates the plans’ aggregate funded ratio has fallen to 70%, down from 75% at the end of 2011 and 81% at year-end 2010.

“If you ended the year right there, that’s going to mean very large balance-sheet adjustments, very large P&L hits for 2013, very large cash contribution requirements,” Barry says, summing up the pension situation as putting “a lot of pressure on companies.”

Underfunding has increased even though companies have poured money into their plans over the last few years, and Barry says that companies are likely to continue making big contributions. “To be honest, that’s probably going to be the primary tool to remedy the deficits, cash funding.”

In addition to low rates and volatile financial markets, a recent Mercer report points to other factors affecting funding. The Moving Ahead for Progress in the 21st Century Act enacted this summer gave companies leeway to lower their funding requirements, but also increased the premiums that plan sponsors pay to the Pension Benefit Guaranty Corp. And a change in the Society of Actuaries’ mortality assumptions could boost plans’ liabilities by 2% to 8%, Barry says, depending on a plan’s demographics and whether it pays lump sums or annuities.

Given the financial pressure on plan sponsors, Barry says it’s likely that more companies will choose to freeze or close plans. “This is a trend that’s been going on for the last several years at a pretty good clip and I don’t see that slowing down.”

Jon Waite, director of investment management advice and chief actuary for the institutional business at SEI Investments, disagrees.“We’ve been through such a dramatic time over the past several years that the plans that have to freeze because of funding levels have done so.”

A recent SEI survey of 110 plan sponsors shows just 44% have plans that are still open to new hires, while 56% are closed or frozen.

 

For previous coverage of pension issues, see Obama Signs Pension Changes into Law, GM Cuts Pension Obligations and Half of Pension Plans Still Active.

 

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