Pension Plans Face Funding Challenges
The consultant’s analysis of S&P 1500 pension plans revealed a similar decrease to what Mercer research found at the end of 2011, but funded status has increased so far in 2013. Despite recent run-ups, pension volatility remains top of mind for plan sponsors. U.S. companies are looking at multiple strategies, including investment allocation, lump sum programs and annuity buyouts to manage pension risk.
“The number of pension plans posing material balance sheet risks rose in 2012, as strong asset performance coupled with high contributions from plan sponsors wasn’t enough to offset declining discount rates,” said Eric Veletzos, a principal in Mercer’s Retirement business. “The question at hand for 2013 is whether plan sponsors are positioned to capitalize on the dramatic funded status improvement we have seen so far this year and make moves to reduce the balance sheet risk by the time year-end 2013 rolls around.”
Veletzos added, “We believe plan sponsors need to develop and implement comprehensive pension financial management strategies, which incorporate both risk-retention and risk-transfer components, to deal effectively with pension risks.”
Mercer research found that for U.S. pension plans, fiscal year 2012 saw assets performing well, coupled with high contributions from plan sponsors. However, it was not enough to improve funded status. Due to declining discount rates, the funded status of U.S. plans still dropped over the 12 months of the fiscal year.
The 2012 median asset return was 12.2% compared with the expected 7.5%. Plan contributions for 2012 totaled $81 billion. The median discount rate for 2012 went from 4.75% to 4%. Altogether, Mercer found this resulted in an average funded status for S&P 1500 plans of 72% for 2012, compared with 75% in 2011.
Mercer also found the number of pension plans posing material balance sheet risks at U.S. companies has risen over the past few years, meaning pension risk has appeared on the radar for senior leadership. According to the analysis, these plans tend to be more poorly funded and are material, compared with the size of the corporation. In 2010, the percentage of risky pension plans among S&P 1500 companies in the U.S. totaled 4%. In 2011, it was 7%. And in 2012, it was 9%.
Research also revealed that ongoing volatility in funded status and in the markets resulted in fluctuating plan expenses, making budgeting difficult for plan sponsors.
Mercer found plan sponsors are continuing their interest in risk management strategies that will help reduce the funded status volatility. Plan sponsors continue to explore strategies ranging from retaining and managing the pension risk to transferring the risk, either to employees via cashouts or to insurers via buyouts.
In terms of specific actions that plan sponsors are planning to take to mitigate pension risk in the future, 78% intend to increase allocation to fixed income, 77% intend to employ dynamic de-risking strategies, 67% intend to provide lump sum cashouts to terminated vested employees, and 48% intend to purchase annuities.