During 2014, aggregate funded status1 for defined benefit (DB) plans in the Towers Watson Pension 100 (TW Pension 100)2 fell from 89% to 81%. While plan assets gained value, falling interest rates coupled with updated mortality assumptions3 significantly increased liabilities, thus wiping out most of the previous year’s gains.

This annual analysis is based on just-reported pension disclosures from the Securities and Exchange Commission 10-K filings of 100 publicly traded U.S. sponsors of large pension plans whose fiscal years end in December.4 We examine reported funding results, the discount rates used to measure liabilities, the effect of new mortality assumptions on the projected benefit obligation (PBO), target asset allocation policy for 2015, return on investment and sponsors’ 2014 contributions. Where applicable, historical values shown are for companies in the 2014 TW Pension 100.

Funded status weakens and overall deficit climbs again in 2014

The gap between liabilities and assets veered from an $82 billion surplus in 2007 to a record-high $297 billion shortfall at year-end 2012 (Figure 1). During 2013, assets grew, interest rates rose (for the first time in four years) and plan obligations declined accordingly, thus reducing the funding shortfall from $297 billion in 2012 to $128 billion in 2013. By year-end 2014, however, the aggregate pension deficit for the TW Pension 100 was back up to $248 billion; sponsors are not yet out of the funding hole dug by the 2008 financial crisis. There have been some net gains since year-end 2008: Aggregate liabilities are up by 40%, while aggregate assets are up by 44%.

Assets in the TW Pension 100 plans grew by 3% over 2014, while plan obligations rose by 13%.5 Investment returns were higher than expected and sponsors made relatively large plan contributions (albeit smaller than those in prior years).

The pension deficit increased from $127.9 billion in 2013 to $248.2 billion in 2014 — an increase of $120.3 billion or 94% — close to double the previous year’s deficit.

Figure 1. Aggregate year-end funded status for TW Pension 100 ($ billions), 2007 – 2014
Figure 1. Aggregate year-end funded status for TW Pension 100 ($ billions), 2007 – 2014

Source: Towers Watson

Average funded status for the TW Pension 100 was 82.2% at year-end 2014, down considerably from 90.2% for 2013 but still up from 77.1% for 2012 (Figure 2). For the second year running, average funded status was slightly higher than aggregate funded status, indicating that plan funding was slightly lower among the largest of these DB plans.

Figure 2. Funded status (%) for TW Pension 100, 2007 – 2014
Figure 2. Funded status (%) for TW Pension 100, 2007 – 2014

Source: Towers Watson

Figure 3 depicts the distribution of funded status since 2007 and shows some major shifts. At year-end 2014, funded status was 80% or more for 56 of these programs (100% or more for six of those). At year-end 2013, funding levels were 80% or higher for 81 programs (100% or more for 19 of those). Just before the financial crisis, more than half the TW Pension 100 had fully funded pensions.

Figure 3. Distribution of funded status for TW Pension 100, 2007 – 2014
Figure 3. Distribution of funded status for TW Pension 100, 2007 – 2014

Source:  Towers Watson

Figure 4 shows changes in funded status from the 2013 to the 2014 plan year. Funded status increased for seven plan sponsors and declined for the other 93, with the decline typically between 5% and 9.9%.

Figure 4. Changes in funded status for TW Pension 100, 2013 – 2014
Figure 4. Changes in funded status for TW Pension 100, 2013 – 2014

Source: Towers Watson

Discount rates fall back to 2012 levels

Plan obligations rose in 2014 mainly because of lower interest rates. From 2008 through 2012, discount rates fell every year, before finally rising in 2013 (Figure 5). Then in 2014, the average discount rate fell by 83 basis points — from 4.85% to 4.02%, thereby increasing pension liabilities by 10%. At year-end 2014, the average discount rate was 236 basis points lower than it was in 2008.

Figure 5. Average year-end discount rate assumptions for TW Pension 100, 2007 – 2014
Figure 5. Average year-end discount rate assumptions for TW Pension 100, 2007 – 2014

Source: Towers Watson

New mortality tables push liabilities even higher

During 2014, one-time improvements in mortality assumptions played a significant role in driving up pension liabilities. The Society of Actuaries (SOA) published updated mortality tables and a new mortality projection scale in October 2014. The updates reflect historical and projected longevity improvements among workers, which increase the number of years employers have to pay out benefits in the future. The vast majority of plan sponsors updated their mortality assumptions (in a variety of ways) at the end of 2014, which increased aggregate PBO for the TW Pension 100 by 4.3% or $55 billion.6

Sponsors continue shifting to fixed-income allocations

For several years now, many plan sponsors have been gradually reducing their investment risk by shifting asset allocations from public equities to fixed-income and alternative investments (Figure 6).7  Since 2009, average allocations to public equities have fallen by 13 percentage points, while allocations to fixed-income investments have risen by nine percentage points.

Of the 94 companies that reported target asset allocation strategies for 2014 and 2015, nine reduced their target equity allocations by five percentage points or more, with an average reduction of 13 percentage points. On the other hand, six sponsors upped their exposure to equity by five percentage points or more, with an average increase of eight percentage points.

Figure 6. Average target asset allocation percentages for TW Pension 100, 2009 – 2015
Click Image to Enlarge
Figure 6. Average target asset allocation percentages for TW Pension 100, 2009 – 2015

Source: Towers Watson

For 2015, aggregate results (weighted by plan assets) differ from average results, which also occurred in earlier analyses. On an aggregate level, sponsors hold less public equity, and more debt and alternative investments, indicating that the largest TW Pension 100 plans have more fixed-income and alternative investments than the smallest (relatively speaking) of these large plans.

Investment returns were positive, especially for fixed-income holdings

During 2014, investment returns varied significantly by asset class. Equity markets were good and bond returns were very strong, especially for long corporate and Treasury bonds. At year-end 2014, both aggregate returns (weighted by plan assets) and average returns exceeded expectations at 9.7% and 9.8%, respectively (Figure 7).8

Plan sponsors using liability-driven investment (LDI) strategies had good results in 2014, as long bond returns offset declining interest rates.9 Long government and long corporate bonds realized returns of 26% and 15%, respectively. Twenty-nine of these pension sponsors had target fixed-income holdings of 50% or more going into 2015, and the average 2014 return for this group was 12.3%. For companies holding more than 60% in debt, the average return was 14.2%. On the other side of the spectrum, the average 2014 return for the 25 companies with less than 30% targeted to fixed-income assets was 7.4%.

Figure 7. Investment returns for TW Pension 100, 2008 – 2014
Click Image to Enlarge
Figure 7. Investment returns for TW Pension 100, 2008 – 2014

Source: Towers Watson

While many factors other than investment returns affect funded status, it is interesting that six of the seven companies whose funded status improved in 2014 had fixed-income allocations of 50% or more going into 2015. While these plans might have missed out on the strong equity gains in 2013, their fixed-income allocations were able to offset the effects of falling discount rates in 2014.

To further illustrate the hedging effects of liability-driven investing in a declining interest rate environment, we look at the relationship between asset growth (aggregate investment returns) and movements in PBO due to changing interest rates (actuarial gain/loss), as well as the expected growth in liabilities due to the passage of time during the year (interest cost), based on sponsors’ fixed-income allocations (Figure 8).

Those with 70% or more in debt had investment returns of $10.5 billion — offsetting their $10.4 billion increase in liabilities due to interest rate changes and interest cost. The correlation between asset returns and liability growth weakens as the percentage in fixed-income asset holdings declines. Plans with less than 30% in fixed income (and large public equity and alternative investment holdings) had investment returns of $12.8 billion, not enough to offset the $33.9 billion increase in liabilities due to interest.

Figure 8. Aggregate investment returns versus liability increases ($ billions), 2014
Figure 8. Aggregate investment returns versus liability increases ($ billions), 2014

Source: Towers Watson

Employer contributions lowest since 2008

Companies made relatively large contributions to their DB plans for 2014, albeit not as large as in prior years (Figure 9). The 2012 Moving Ahead for Progress in the 21st Century Act (MAP-21) and the 2014 Highway and Transportation Funding Act allowed sponsors to significantly reduce minimum required contributions starting with the 2012 plan year (by using a long-term average discount rate, which is much higher than what is otherwise required). Many sponsors appear to have opted for the funding relief again in 2014,10 as contributions dropped to their lowest level in six years. Since 2008, the TW Pension 100 has contributed more than $230 billion to their plans.

For 2014, plan sponsors contributed $26.5 billion, down slightly from $27.8 billion in 2013 and down significantly from $44.7 billion in 2012.

Figure 9. Plan contributions from TW Pension 100 ($ billions), 2008 – 2014
Figure 9. Plan contributions from TW Pension 100 ($ billions), 2008 – 2014

Source: Towers Watson

Half of the companies in this analysis contributed less in 2014 than in 2013. Forty-five sponsors contributed more in 2014 than they did for 2013, and five contributed the same amounts in both years. It seems as if sponsors that made large contributions in 2013 cut back in 2014, and sponsors that made smaller contributions in 2013 upped their contributions in 2014 (Figure 10).

Figure 10. Plan contributions ($ billions), 2013 versus 2014
Figure 10. Plan contributions ($ billions), 2013 versus 2014

Source: Towers Watson

Despite the lower contributions in 2014, the median ratio of contributions to service cost was 1.3, so companies are contributing considerably more than necessary to keep pace with benefit accruals.

Further de-risking of pension liabilities in 2014

To alleviate some of the risk that comes with managing large pension obligations, some plan sponsors have offered lump sum buyouts or executed bulk annuity purchases for certain DB plan participants in the last few years. In 2012 filings, 12 companies explicitly stated having taken such actions, which reduced aggregate assets and obligations by $42 billion.11

During 2014, some TW Pension 100 sponsors took steps to reduce the size of their pension obligations. According to explicit disclosures, 23 of these sponsors made lump sum offers or executed bulk annuity purchases, reducing aggregate assets and liabilities by roughly $14 billion.

Conclusion

During 2014, falling interest rates coupled with one-time changes to mortality assumptions pushed plan liabilities significantly higher. While investment returns were good, cash contributions (while still relatively high) were the lowest since the financial crisis. So asset gains were not sufficient to offset dramatically lower funding positions that wiped out a good portion of 2013’s gains.

Lower funding levels are a concern for plan sponsors. Weaker funding positions will likely necessitate larger cash contributions in the near future, and higher pension costs will most likely drive up the charge against profits for 2015, unless equity returns are strong and/or interest rates rise.

De-risking pension plans continues to be important to many sponsors, as evidenced by another year of lump sum buyouts and annuity purchases. Already in 2015, three companies in the TW Pension 100 have started the process of transferring some plan obligations to a third-party insurance carrier.

Plan sponsors that adopted an LDI approach to hedge falling interest rates saw this strategy succeed for 2014. It will be interesting to see how the drop in pension funding levels and interest rates affects risk mitigation efforts during 2015.


Endnotes

1. Aggregate funded status is the ratio of (a) the sum of all pension assets to (b) the sum of all pension benefit obligations. Average funded status is calculated by averaging the ratio of (a) to (b) on an individual company basis.

2. The 2014 TW Pension 100 consists of sponsors of the 100 largest U.S. pension programs among U.S. publicly traded organizations, ranked by PBO at year-end 2013. For some companies, the allocation of disclosed PBO and assets between U.S. and non-U.S. is estimated.

3. See “SOA Publishes Final Reports on Updated Mortality Tables,” Towers Watson Insider, December 2014.

5. Aggregate funding among these companies is similar on both a U.S. and a global basis. For all pensions, domestic and foreign, total PBO increased from $1.48 trillion to $1.66 trillion during 2014. Global pension assets rose from $1.29 trillion to $1.34 trillion over the period. So on a global basis, aggregate funded status decreased from 87.4% to 80.7% as of year-end 2014.

6. The effects of mortality table updates were reflected in the actuarial loss line item in the benefit obligation reconciliation table that is part of SEC filings. Eighty-three of the TW Pension 100 noted the adoption of new mortality assumptions in 2014 in their 10-K pension footnote, and 55 of them also explicitly mentioned the associated increase in PBO. We estimated the mortality impact from the actuarial loss line item for 28 companies. Of the 17 companies that did not mention new mortality assumptions in their disclosures, 11 had noticeable differences in their actuarial gain/loss line item from the previous year; we also estimated the mortality impact for these companies. Six of the 17 companies had no noticeable differences in their actuarial gain/loss line item from the prior year, so we assumed they did not update their mortality assumptions (or that the effect was immaterial). The total actuarial loss for the TW Pension 100 was $181 billion in 2014. While other components also affect the actuarial gain/loss line item, they are not expected to be significant in total and our estimates focused only on interest rate changes and mortality adjustments. We attributed $126 billion to lower interest rates and $55 billion to updated mortality assumptions.

7. Target allocation information is usually depicted in ranges in pension disclosures. For purposes of this study, the midpoint of ranges was taken and results were normalized to total 100%.

8. The expected rate of return was roughly 7%, according to an internal survey of year-end plan sponsors.

9. Liability-driven investment strategies use fixed-income assets, typically long bonds, as a hedge against the effect of interest rate movements on plan liabilities. For further information on how these strategies have affected large plan sponsors since the financial crisis, see “TW Pension 100: Investment Strategies and Plan Funding Since the Financial Crisis,” Towers Watson Insider, May 2014.

11. While the majority of these companies used bulk lump sums, the total effect is largely the result of two companies making significant annuity purchases in 2012.