U.S. Pension Plan Funding Recovers in October After Record Lows

This deficit corresponds to an aggregate funded ratio of 75% as of October 31, compared to a funded ratio of 72% at September 30, 2011, and 81% at December 31, 2010.

While the increase is the largest one-month improvement since September 2010, when the funded ratio improved 4%, much of the improvement was wiped out in the first trading day of November, as most equity markets faced significant declines. According to Mercer, plan sponsors continue to be challenged by the tremendous volatility in the markets this year, PPA requirements will trigger significantly higher cash contributions in 2012 for most plans and create cash flow problems for some sponsors.

The increase in funded status was driven by an 11% gain in equities, partially offset by the continued decrease in yields on high quality corporate bonds during October. Discount rates for the typical U.S. pension plan decreased approximately 15 basis points during the month. Mercer’s analysis indicates the S&P1500 funded status peaked at 88% at the end of April, and had seen a 16% decline before rebounding this past month.

“Market volatility continues to make many plan sponsors very uneasy,” said Jonathan Barry, a Partner with Mercer’s Retirement, Risk and Finance business, in a news release. “While most of October showed gradual improvement in funded status, we actually saw a 3% drop in funded status in just the last two days of the month. Furthermore, it is likely that much of the gain we saw in October was wiped out in just the first day of November.”

Mercer notes that the impact of 2011 funded status declines will compound an already bleak picture for pension funding requirements. Craig Rosenthal, a Partner with Mercer, who authored Mercer’s recent analysis of 2011 pension funding outcomes, said, “Sizable increases in funding requirements were already expected for 2012, due to declining interest rates, and the results of the further downturn this year could exacerbate the situation. The effect of these recent events will place additional pressure on pension plan funding levels and trigger higher required contributions for coming years due to the short time for funding deficits under PPA.”

Barry adds, “There are many opportunities for plan sponsors to evaluate risk reduction opportunities, through investment strategies, liability transfer opportunities, plan design, and funding policy. For sponsors who are uncomfortable with the risk to which their pension plan exposes them, we strongly encourage them to step back and explore a better way forward.”