In pension plans sponsored by Fortune 1000 companies, assets continued to grow in 2011 — albeit not by much — and asset growth was outpaced by the growth of liabilities. Employers' sizable cash contributions to their plans did not counteract the effects of lower interest rates, which increased liabilities substantially.
Towers Watson analyzed data for the 422 Fortune 1000 companies that sponsor U.S. defined benefit (DB) plans and whose fiscal years end in December, and estimated their plans' funded status — current value of plan assets divided by the projected benefit obligation (PBO) — for year-end 2011. On an aggregate level — total assets divided by total PBO for all 422 firms — we estimate that funded status fell from 84% in 2010 to 78% in 2011, a six-percentage-point decline (see Figure 1).1 Calculated as a simple average of each individual company funded percentage, the funded ratio dropped from 80% in 2010 to an estimated 76% in 2011.
Figure 1. Pension funded status for Fortune 1000 companies (2000-2011)
Source: Towers Watson.
Growth rate of liabilities far outpaces growth of assets
This is the third consecutive year in which the decline in the interest rates used to measure plan obligations swelled plan liabilities. For 2011, the analysis estimates that pension obligations grew by 9% while assets grew by only 1%. Figure 2 shows actual aggregate components for 2010 and estimates for year-end 2011.
Figure 2. Estimated changes in PBO and asset values during 2011 ($ billions)
*Actuarial loss due to interest rate decrease.
Source: Towers Watson.
Assets realize moderate gain
Pension plan assets grow with positive returns and employer contributions, and fall with negative returns, benefit payouts and plan expenses. The modest asset growth experienced in 2011 was due primarily to large plan contributions from plan sponsors. Asset returns, while generally positive, were below expectations over the period — especially among plans with larger concentrations in equities.
To estimate asset returns, we use company-specific asset allocations as of January 1, 2011, as reported in the 10-K pension footnotes required by the Securities and Exchange Commission. We break the allocation into five categories: equity, debt, cash, real estate and other.
Equity returns are based on a 70/30 mix of domestic and international equities. Domestic equity returns are based on the Russell 2500 index, and International equity returns are based on the MSCI EAFE Index.2 Based on these indices, in 2011 domestic equity returns were roughly -2% and international returns were around -13%. Debt returns are based on the Barclays Long Government/Credit Index and were around 17%.
Estimated real estate returns are based on the National Council of Real Estate Investment Fiduciaries Property Index, and returns for other investments (assumed to be hedge funds) are based on Hedge Fund Research Inc.'s Global Hedge Fund Index. Returns for cash are based on three-month Treasury bills. In 2011, these returns were 14% for real estate, -9% for other investments and 0% for cash.
To estimate employers' cash contributions for 2011, we use the greater of actual 2010 contribution amounts disclosed in the 2010 10-K pension footnotes and the amounts employers said they expect to contribute (which is typically the minimum required) in 2011. Because employers are still trying to regain funding ground they lost in 2008, many are likely to have contributed more than the minimum, as was the case last year.
Lower discount rates drive up liabilities
Liabilities increased by an estimated 9% during 2011. Based on our recent internal survey of plan sponsor assumptions coupled with recent movements in interest rates, we estimate a 67-basis-point decline in discount rates from year-end 2010 to year-end 2011.3 Variations in the discount rate significantly affect plan liabilities — the higher liability caused by the lower discount rates is reflected in the actuarial loss shown in Figure 2.4
A decrease in year-end discount rates increases service cost for the following plan year. From year-end 2009 to year-end 2010, discount rates fell from 5.86% to 5.40% for companies in this analysis. Given this decline, we estimate that service cost (actuarial present value of pension benefits employees earned during the year) increased by 7%.5
We estimate interest cost by multiplying the discount rate at the beginning of the year by the PBO for the same period, adjusted by current expected benefit payments over the next year as disclosed in the 2010 10-K pension footnotes.
Distribution of funded levels for Fortune 1000 companies in this analysis
Between year-end 2010 and year-end 2011, the percentage of Fortune 1000 companies whose funded level was less than 70% increased from 21% to an estimated 33% (see Figure 3). At year-end 2010, funded levels were higher than 90% for 20% of plan sponsors. But by year-end 2011, only 11% of sponsors had plans that well funded, according to our estimates. There is an overall downward trend in the distribution of funded status over the past year, although funding is still up relative to 2008. At year-end 2008, funded levels were less than 70% for 57% of the Fortune 1000 plan sponsors.6
Figure 3. Distribution of funded status (year-end 2009, year-end 2010 and estimates for 2011
While employers continue to make sizable cash contributions to their pensions, weak asset returns and declining interest rates reduced the funded status of DB plans for 2011. In 2009 and 2010, average and aggregate funded levels showed year-to-year improvement, largely due to an aggressive contribution strategy from employers and rebounding equity returns. Despite the poor 2011 showing, however, these plans are still in better shape than they were right after the financial crisis — when funding levels averaged 70%.
For companies in this analysis, the aggregate pension deficit grew by more than $110 billion over the last year — from $229 billion to $343 billion. Barring a significant extension of the capital market recovery or a large jump in interest rates (extremely unlikely under current government policies), sponsors will have to contribute even more to their plans over the next few years to fully recover from the 2008 losses as well as from current funding shortfalls.
Endnotes
1Data are derived from companies' 10-K annual reports. Many of the pension liability values in 10-K disclosures incorporate nonqualified plans, which are typically not funded, suggesting the aggregate funding ratio for qualified plans is higher than the values shown in Figure 1.
2MSCI 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 the United States.
3According to an internal survey of plan sponsor assumptions conducted in early January 2011, discount rates are expected to have declined from 5.43% at year-end 2010 to 4.76% at year-end 2011
4We estimate plan duration at 13 years for active plans and nine years for frozen plans.
5While we modeled only the change in service cost arising from interest rate movement, service cost is also affected by pay and employment levels as well as by plan changes that curtail benefits, such as freezes. Addressing these factors, however, would likely not provide any significant gains in overall accuracy, especially given countervailing factors like aging workforces.
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