Significant increases in aggregate contribution requirements lie ahead for single-employer defined benefit (DB) pension plans, according to an updated analysis from the Society of Actuaries (SOA).
This doesn’t mean plan sponsors will immediately have to fork over more money to their pension plans, the SOA report explains. In fact, the SOA actually projects a reduction in the minimum annual required contribution for the next decade or so. Beyond this point the prospects of increasing longevity and weaker returns continue to expand pension liabilities—potentially at problematic rates for all but the healthiest corporations.
The findings are outlined in “The Rising Tide of Pension Contributions Post-2013: How Much and When?,” which updates projections first published in 2011 to account for the effects of higher-than-required average corporate plan contributions, two changes in federal pension law, and better-than-expected market performance over the past three years.
Under the updated analysis, SOA’s projected minimum required contribution levels for private single-employer defined benefit pension plans over the next 10 years (2014 to 2024) declined by 5% percent when compared to the 2011 projections. As noted by SOA researchers, the forecasted aggregate minimum annul contribution requirement for these plans is now approximately $75 billion, down from $79 billion in the previous version of the report.
Dale Hall, SOA managing director of research, notes that despite the reduction in projected minimum required contribution levels between the 2011 and 2015 reports, significant increases in aggregate contribution requirements are still ahead. He says many plans seem to be working to get ahead of this increase, pointing to research findings showing on aggregate, employers contributed more than four times the required annul amount since 2011.
Strong employer contributions coupled with improving economic conditions have strengthened the funding outlook for many plans, Hall explains. “Nevertheless, we expect minimum contribution requirements to rise over the long-term under a range of macroeconomic scenarios.”
Other takeaways from the revised analysis show that, while forecasters generally place an even chance on economic performance coming in above or below baseline projections for the time period studied, underperformance can be much more consequential for short-term funding of the defined benefit system than outperformance. Further complicating pension sponsor strategy, SOA researchers find rising interest rates alone will likely not resolve future increases in funding requirements.
“We note that interest rate declines since June 2014 have reduced measures of plan funding relative to our baseline scenarios,” Hall adds. “Therefore, [an even more] current projection would show slightly higher contribution requirements over the next decade.”
Crucially, the SOA baseline scenario assumes that interest rates rise in a steady and orderly fashion over the next two years or so, with 10-year Treasury yields peaking just above 5% in late-2016 before settling just below 5% afterwards. Corporate earnings are also assumed to rise steadily by the SOA, supporting further stock price increases. Should unemployment continue to abate through the projection period and should Washington politicians come close to a goal of stabilizing the nation’s debt-to-GDP ratio, the future may look even brighter for U.S. pensions, SOA says.
“Despite forecasted interest rate increases, we expect contribution requirements to increase significantly as the effects of pension funding stabilization wear away,” the report continues. “Over the 10 years beginning in 2014, we project contribution requirements to average $75 billion per year, adjusting for inflation. This is down from our 2011 analysis, which projected an average $87 billion per year for the 10 years beginning in 2010 after adjusting for inflation.”
SOA says it is also worth noting that, while contribution requirements are expected to increase beyond the next decade, an average annual requirement of $75 billion per year is less than the average $92 billion that sponsors contributed to the system each year from 2010 through 2012, and the annual average $87 billion that sponsors contributed over the 10-year period ending with 2012.
“Therefore, in our baseline scenario, we expect an overall downward trend in actual contributions to the system,” researchers explain.
The full analysis, including extensive description of the SOA’s models, assumptions and underlying data, can be downloaded at www.soa.org.