Buoyed by strong market returns and larger-than-expected employer contributions — but weakened by historically low discount rates — the projected funded status of pension plans sponsored by the nation’s largest corporations realized modest gains in 2017, rising from 81% to 83%.

For this annual study,1 Willis Towers Watson analyzed 389 Fortune 1000 companies that sponsor U.S. defined benefit (DB) plans with fiscal years ending in December.2 We estimate funded status for 2017 on an accounting basis, which is the value of plan assets divided by the projected benefit obligation (PBO). On an aggregate basis — total assets divided by total liabilities for all 389 firms — funded status ticked up to an estimated 83%, after holding at 81% for the previous three years (Figure 1).

Figure 1. Aggregate funded status of Fortune 1000 pensions, 2000 – 2017

Figure 1. Aggregate funded status of Fortune 1000 pensions, 2000 – 2017

Source: Willis Towers Watson calculations based on companies’ 10-K annual reports filed with the Securities and Exchange Commission (SEC)

These companies’ estimated pension deficit declined by $25 billion, dropping from $317 billion at year-end 2016 to $292 billion by year-end 2017.

Pension liabilities climb; assets climb higher

Over 2017, the interest rates used to measure pension obligations — high-quality (AA), long-duration corporate bond yields — dropped by 51 basis points, and lower interest rates drove the PBO higher. Investment returns were very strong for the year, and sponsors made higher contributions than they had in the past. Thus, while the PBO grew by an estimated 4%, plan assets were up by 6.8%. The components are shown in Figure 2.

Figure 2. Estimated changes in PBO and asset values during 2017 ($ millions)

Projected benefit obligations Plan assets
PBO end of 2016 $1,651,393 Plan assets end of 2016 $1,334,582
Service cost $26,392 Employer contributions $51,240
Interest cost $65,098 Actual investment return $167,691
Discount rate change $102,601
Mortality assumption change –$1,718
Bulk lump sum/annuity purchases –$25,000 Bulk lump sum/annuity purchases –$26,250
Other benefits paid –$102,038 Other benefits paid –$102,038
PBO year-end 2017 $1,716,728 Assets year-end 2017 $1,425,225
Change during 2017 4.0% Change during 2017 6.8%

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

Pension obligations have been declining over the past few years (before factoring in settlements, changes in interest rates, and mortality and other assumptions), as benefit payments flowing out of these plans now exceed service cost (the value of benefits accrued during the year) and interest cost. This can be attributed to an uptick in pension freezes over the past decade,3 which has been reducing aggregate service cost over time. Liability settlement activity over the past five years has also played a part in reducing aggregate PBO.

Another year of lower interest rates drives up liabilities

The increase in PBO during 2017 would not have occurred without the interest rate decline (Figure 3). Based on Willis Towers Watson’s modeling and movements in high-quality long-duration corporate bond yields, we estimate a discount rate decline of 51 basis points from 2016 to 2017, which constitutes a historical low. Changes in the discount rate significantly affect pension liabilities: The higher liability caused by the lower discount rate is reflected in the discount rate change line in Figure 2.4

Figure 3. Average discount rates used by Fortune 1000 companies, 2000 – 2017

Figure 3. Average discount rates used by Fortune 1000 companies, 2000 – 2017

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

In 2014, the Society of Actuaries (SOA) published new mortality tables and projection scales that reflected past and anticipated longevity improvements, prompting many companies to revise funding assumptions, which drove up plan liabilities by 4% on average. The SOA has since updated the projection scales annually to reflect slightly lower life expectancies, and again some sponsors adjusted their assumptions accordingly, including in 2017. Meanwhile, many companies are adopting the 2018 minimum required lump sum mortality assumptions (based on new government regulations) for the first time, which will increase the PBO. We project a net PBO reduction of 0.1% due to these changing mortality assumptions.

In 2017, employers continued to settle liabilities through lump sum buyouts and annuity purchases. We reduced projected PBO by $25 billion due to such settlements (which are estimated to cost 5% more than the associated PBO).

Strong investment returns plus larger employer contributions drive asset values higher

Equity markets continued to prosper in 2017. Bond returns were also strong, especially for long-duration bonds, which are typically used in liability-driven investment (LDI) strategies.5 Aggregate investment returns for 2017 are estimated at 13.1%, well above expectations of 7%. To estimate asset returns, we used company-specific asset allocations as of January 1, 2017, as reported in the 10-K footnotes. We categorized assets as public equity, private equity, debt, cash, real estate, hedge funds and other.

We based equity returns on a 60/15/25 mix of domestic large capitalization, domestic small/mid-capitalization and international equities. We based large-cap returns on the S&P 500 Total Return Index, small/mid-cap returns on the Russell 2500 Index and international equities on the MSCI EAFE Index.6 Equity returns varied, with international equities up 25%, while small/mid-cap equities were up 17%. Estimates for private equities were assumed to be the same as returns for public equities: 22% for 2017.

Debt returns were based on a 55/22.5/22.5 mix of Barclays Aggregate Index, Barclays Long Government Index and Barclays Long Credit Index. Long corporate and long government bonds, typically used in LDI strategies, earned 12.2% and 8.5%, respectively. So, in another year of declining interest rates, sponsors using LDI strategies successfully hedged against the interest rate drop — but missed some gains from the equity windfall. Total debt returns were estimated at 7% for 2017.

Estimated real estate returns were based on a blend of the National Council of Real Estate Investment Fiduciaries Property Index7 and the Vanguard REIT Index Fund, and returns for hedge funds were based on Hedge Fund Research’s Global Hedge Fund Index. Returns for cash were based on three-month Treasury bills. Estimates for other returns were based on a 50/50 blend of equity and debt returns. In 2017, returns were 5.9% for real estate, 6% for hedge funds, 0.1% for cash and 14.2% for other.

To estimate employers’ cash contributions for 2017, we generally used projected contributions from prior-year disclosures.8 We estimated 2017 plan contributions at $51.2 billion — up roughly 20% from last year ($43.1 billion). Contributions were nearly twice the amount needed to cover benefits accruing during the year. Higher aggregate contributions were mostly due to higher-than-expected contributions from several large plan sponsors, which could be a response to rising Pension Benefit Guaranty Corporation premiums, a desire to prefund future contributions, growing interest in de-risking strategies and the possibility of lower corporate tax rates.9

Conclusion

Robust investment returns combined with larger-than-expected plan contributions offset the higher PBO caused by yet another year of declining interest rates. At 83%, funding levels were (modestly) higher than they have been since 2013.

The uptick in funded status is welcome news. As for the future, many plan sponsors are just now digesting the new tax law and the implications for their benefit plans. Employers should consider their broader pension management strategy as they make that evaluation, which could mean reviewing their investment strategy or implementing pension de-risking strategies, such as an annuity purchase.


Endnotes

1. See “After a few ups and downs, corporate pension funding levels showed little change in 2016,” Willis Towers Watson Insider, February 2017.
2. Data are derived from companies’ 2017 10-K annual reports. Where U.S. and non-U.S. pensions were disclosed separately, only U.S. pension information was used. Pension liability values in 10-Ks also reflect nonqualified plans (which are usually not shown separately). An analysis of companies that disclose their qualified and nonqualified plans separately found that funded status is around 8% higher without the nonqualified plan obligations because these plans are typically not funded.
3. See “Retirement plan offerings in the Fortune 500: A retrospective,” Willis Towers Watson Insider, February 2018.
4. The duration of pension liabilities for each company is based on the benefit-payout-to-obligation ratio derived from 10-K disclosures. The estimated duration for pension obligations is 12.6 years.
5. LDI strategies generally use fixed-income assets, typically long bonds, as a hedge against the effect of interest rate movements on plan obligations.
6. The MSCI EAFE Index measures the equity market performance of developed markets outside the U.S. and Canada.
7. Real estate assumptions are as of September 30, 2017.
8. In some cases, expected year-end values reported in the third quarter 10-Q were used when a company noted a substantial change from what had been reported in its annual 10-K.
9. The tax deduction for pension contributions was higher under former tax law. Many employers may still make contributions through some part of 2018 under the old rules.