The Milliman Multiemployer Pension Funding Study report says the overall funding shortfall for all plans declined by $45 billion for the year ending December 31, 2013, and the aggregate funded percentage increased by 9% from 72% to 81%.
The significant improvement in aggregate funded status since early 2009 reflects not only favorable investment returns, but also contribution increases (including withdrawal liability collections) and benefit reductions enacted by plans as they responded to the financial crisis. Milliman says one common misconception is that plans should be back on their feet because the stock market has surpassed its levels from before the financial crisis. However, liabilities have been growing at 7.5% per year on average, so market prices would need to be about 50% higher today to have kept pace with liability growth.
While aggregate funding levels of multiemployer plans have nearly returned to pre-crash levels, the financial crisis has affected individual plans in different ways. The median multiemployer funded percentage of 86% as of December 31, 2013, has nearly recovered to its pre-crash level of 89%. However, the proportion of plans that are less than 80% funded has increased from 29% to 37%.
What is keeping some plans from recovering to the funding levels trustees and participants would hope for? One of the primary challenges facing traditional defined benefit (DB) plans, according to Milliman, is that they have become more mature and have less ability to recover from poor experience. Plan maturity means the number of participants who are still actively working is smaller than those who are either pensioners in pay status or vested inactive participants with a right to a deferred benefit.
From 2002 to 2012, the active population of multiemployer plans has decreased from 48% to 37% with a corresponding increase in the size of the inactive population. As a plan matures there are relatively fewer participants on whose behalf contributions are being made into pension funds, with an ever-growing level of participants entitled to current or future benefits putting a significant financial strain on these funds. In addition, Milliman explains, as a plan becomes more mature, contributions become relatively small compared with the size of the plan’s assets and liabilities, and so contribution increases are less effective at improving the plan’s funded level.
This negative cash flow—benefit payments and plan expenses increasingly outweigh contributions—magnifies the impact of investment volatility and makes it harder for plans to recover from an underfunded status, as they are forced to liquidate assets to meet obligations before asset values can recover.
The study found more mature plans are more likely to be in the yellow or red zone—plans that are less than 80% funded per the classification in the Pension Protection Act—than less mature plans. For more mature plans, the corrective tools available such as contribution increases and benefit reductions for non-retired participants are not as effective since the non-retired population is so small, so these plans have had more trouble avoiding the yellow or red zones.
According to Milliman, more than half of all plans would still need to earn 8% or more over the next 10 years to reach 100% funding. For all plans in aggregate, returns of 8.75% as of December 31, 2013, are needed over the next 10 years as compared with 10.30% as of December 31, 2012. Even if a plan recovers to 100% funding, the assumed rate of return used by these plans to calculate funding (7.5% on average) is still needed to stay fully funded.
The full study report is here.