During 2013, the funded status of corporate pension plans jumped to the highest level since before the 2008 financial crisis. Strong equity returns coupled with substantial employer contributions gave plan assets a boost, and the higher interest rates used to measure pension obligations reduced liabilities.

Towers Watson analyzed data for 418 Fortune 1000 companies that sponsor U.S. defined benefit plans with fiscal years ending in December. We estimated funded status — current value of plan assets divided by projected benefit obligation (PBO) — for year-end 2013. On an aggregate basis — total assets divided by total liabilities for all 418 firms — pension funded status rose to an estimated 93%, an increase of 16 percentage points from year-end 2012 and the highest funded ratio in many years (Figure 1).1 While aggregate plan funding increased by $285 billion in 2013, these plan sponsors still have a $99 billion deficit to fill.

Calculated as a simple average of each plan’s funded ratio, funded status increased from 74% to 92% over 2013. This statistic gives more prominence to smaller plans in the group, and average funded status has typically been lower than the aggregate measure.

Figure 1. Aggregate and average funded status of Fortune 1000 pensions (2000 – 2013)
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Source: Towers Watson calculations based on companies’ 10-K annual reports filed with the Securities and Exchange Commission (SEC)

Pension assets grow, while liabilities decline in roughly equal measure

After falling for four consecutive years, interest rates finally ticked back up, thus driving pension obligations down. Over the same period, strong stock market returns and employer contributions pushed up the value of plan assets. For 2013, pension obligations are estimated to have declined by nearly 10%, while assets are estimated to have grown by roughly 9%. Figure 2 shows the components underlying the funding improvement in 2013.

Figure 2. Estimated changes in projected benefit obligation and asset values during 2013 ($ millions)
Towers Watson Insider Estimated changes in projected benefit obligation and asset values during 2013 ($ millions)

*Estimated actuarial gain due to interest rate change
Source: Towers Watson calculations based on companies’ 10-K annual reports filed with the SEC

Assets realize significant gains

Equity markets substantially exceeded expectations for 2013, which increased the value of pension assets, especially in plans with large concentrations of equities. In contrast, returns on bonds were poor during this period due to the rise in interest rates.

To estimate asset returns, we used company-specific asset allocations as of January 1, 2013, as reported in the 10-K pension footnotes. We categorized asset allocations into equity, debt, cash, real estate and other.

We based equity returns on a 70/30 mix of domestic and international equities. Using the Russell 2500 index for domestic equities and the MSCI EAFE Index2 for international equities, equity returns were around 32% for 2013. We based debt returns on a 60/20/20 mix of Barclays Aggregate Index, Barclays Long Government Index and Barclays Long Credit Index. Total debt returns were around -5% over 2013. Estimated real estate returns were based on the National Council of Real Estate Investment Fiduciaries Property Index,3 and returns for other investments (assumed to be hedge funds) were based on Hedge Fund Research’s Global Hedge Fund Index. Returns for cash were based on three-month Treasury bills. In 2013, the returns were roughly 3% for real estate, 7% for other investments and 0% for cash. Aggregate investment returns for 2013 are estimated to be 13% for plan sponsors in this analysis.

To estimate employers’ pension contributions for 2013, we used the greater of the amount employers planned to contribute for 2013 (based on their prior year disclosures) and 140% of service cost (the actuarial value of benefits attributed to 2013).4 We estimated $48.8 billion in pension contributions for plan sponsors for 2013, which is 23% less than these companies contributed in 2012. Some companies likely took advantage of the funding relief enacted in the Moving Ahead for Progress in the 21st Century Act, which drove down required contributions, and chose to deploy cash elsewhere. In addition, very large contributions from prior years coupled with improving financial market performance over 2013 prompted some plan sponsors to adjust their contribution schedules.

Interest rates increase for first time since 2008, pushing down liabilities

Pension liabilities decreased by an estimated 10% during 2013. After four consecutive years of falling, the interest rates used to measure pension obligations increased in 2013 (Figure 3). Based on a Towers Watson internal survey of plan sponsors and recent interest rate movements, we estimate that discount rates increased by 84 basis points from year-end 2012 to year-end 2013. Changes in the discount rate significantly affect pension liabilities; the lower liability caused by the higher discount rate is reflected in the actuarial gain shown in Figure 2.5

Figure 3. Discount rates used by Fortune 1000 companies with year-end measurement dates (2006 – 2013)
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Source: Towers Watson calculations based on companies’ 10-K annual reports filed with the SEC

Distribution of pension funding results

Between year-end 2011 and year-end 2013, the percentage of Fortune 1000 pension plan sponsors whose funded status exceeded 90% jumped from 11% to an estimated 56% (Figure 4). Twenty-seven percent of companies are estimated to have fully funded plans as of year-end 2013. Funded status was less than 70% for 38% of plans at year-end 2011 compared with 7% of plans at year-end 2013.

Figure 4. Distribution of funded status of Fortune 1000 pensions (year-end 2011, year-end 2012 and estimates for year-end 2013)
Towers Watson Insider: Distribution of funded status of Fortune 1000 pensions (year-end 2011, year-end 2012 and estimates for year-end 2013)

Source: Towers Watson calculations based on companies’ 10-K annual reports filed with the SEC

Conclusion

During 2013, rising interest rates reduced pension liabilities while very strong stock market returns boosted plan assets, which should push pension funding levels significantly higher for corporate pension plan sponsors. Aggregate funding levels for the Fortune 1000 are estimated to have increased by 16 percentage points — from 77% to 93% — reaching their highest levels since 2007.

The funding improvement is good news for plan sponsors. Stronger pension fund balance sheets will reduce required cash contributions in the near future, and lower pension cost will also decrease the charge against profits for 2014, thereby improving earnings for these companies.

As de-risking pension plans continues to be of great importance for pension sponsors, it will be interesting to see how the improved funding affects risk mitigation efforts this year. Sponsors who have already implemented a risk reduction plan and use trigger points linked to funding levels to govern their strategy may see opportunities to take action in 2014.


Endnotes

1. Data were derived from companies’ 10-K annual reports. Where U.S. and non-U.S. pensions were disclosed separately, only U.S. pension data were used for this analysis. Pension liability values in 10-Ks incorporate nonqualified plans, which are typically not funded, suggesting that the aggregate funded ratios for qualified plans are even higher than the values shown in Figure 1.

2. MSCI EAFE stands for Morgan Stanley Capital International Europe, Australasia and Far East. The MSCI EAFE index includes developed and emerging markets around the world except North America.

3. Real estate assumptions are as of September 30, 2013.

4. The 140% is derived from an internal Towers Watson survey of year-end plan sponsors on cash contributions.

5. Duration is based on a benefit-payout-to-obligation ratio derived from 10-K disclosures. The average duration for pension plan obligations was 13.3 years. Weighted by plan liabilities, average duration was 13.1 years.