The good news is that the number of underfunded U.S. corporate defined-benefit pension plans in 2012 was the same as the year before.
The bad news: That number is still a whopping 94%.
According to a recent report by Wilshire Consulting, strong equity returns last year weren’t enough to offset the increased liabilities at S&P 500 pension plans. The aggregate funding ratio dropped from 79.7% in 2011 to 78.1% last year. To put that into perspective, when Wilshire did its initial survey of corporate pension plans in 2000, the aggregate funding among S&P 500 companies was 125%—a 25% surplus of assets to liabilities. “A lot of that surplus was the result of a strong decade in the capital markets,” says Russ Walker, vice president at Wilshire Associates and co-author of the 2013 Wilshire Consulting Report on Corporate Pension Funding Levels.
He notes that aggregate funding has danced between surpluses and deficits since 2000, largely mimicking the swings in the financial markets. Pension plan asset levels are determined by the market performance of the underlying assets and by the amount of company contributions. They’re also impacted by interest rates, which can affect both the returns on a pension’s fixed-income securities and accounting for the present value of future pension obligations.
Despite a solid year for stocks and modest increases in contributions by S&P 500 companies in 2012 (aggregate pension plan assets rose $113 billion to more than $1.2 trillion), the current low interest rates used to discount future benefits made those obligations greater than they would have been in a higher interest rate environment. That boosted pension liabilities for the year and contributed to an overall $342.5 billion funding shortfall, roughly 18% greater than the prior year’s shortfall.
“There are a lot of moving parts to calculating pension plan benefits,” Walker says. “Corporations want to tamp volatility by matching assets to their liabilities.”
To smooth the ride, companies increasingly are looking at a strategy called liability-driven investing (LDI). The discount rate used by pension plans to account for their long-term obligations is based on the interest rates of high-quality corporate bonds, and LDI can employ various methods to better align plan assets and liabilities.
These could include hedging strategies and increased fixed-income allocations, but greater reliance on bonds could mean smaller return on investments for pension plan portfolios. “There are no easy solutions,” Walker says.