Human Capital & Careers

Pension Plans Grow More Bearish

They've downgraded their expectations on returns for the next five years by almost a full percentage point.
Stephen TaubFebruary 2, 2009

Corporations should brace for a major pension shortfall over the next five years or so, according to a new study by Greenwich Associates.

U.S. pension funds have sharply ratcheted down their expected investment returns from most major asset classes through 2013, Greenwich reported. The consulting firm each year asks more than 1,000 U.S. institutions to disclose the annual rates of return they are expecting on individual asset classes for the next five years.

In its most recent round of interviews — conducted from July to October 2008 — corporate pension funds said they reduced investment returns on plan assets to an annual 7.4 percent from the 8.2 percent they were looking for in 2007, while public funds cut overall portfolio return expectations to 7.6 percent from 8.5 percent.

“U.S. pension funds are not expecting a quick recovery in investment markets,” said Greenwich Associates consultant William Wechsler. “They are planning for a slow-growth environment for asset valuations that they expect to continue for the next five years.”

Drilling down by asset class, pension funds have slashed their return expectations for U.S. equities. For example, corporate plans are now looking for annual rates of return of 7.8 percent, down from 8.6 percent, which they were expecting in 2007, while public plans have cut their anticipated returns to 7.9 percent from 9.1 percent.

Both groups also reduced their return expectations on fixed income, with public plans cutting annual expectations to 5 percent from 5.8 percent and corporate plans reducing expected returns to 5.2 percent from 5.6 percent.

Greenwich also said pension funds reported substantial reductions in expected returns on international equity, equity real estate, private equity, and hedge funds.

Both groups expect private equity to generate the highest returns of any asset class over the next five years; public funds are projecting an annual 11.3 percent return, while corporate funds are expecting 10.1 percent.

But the survey findings might already be growing obsolete. “It is important to remember the extent to which markets have deteriorated since these interviews were completed in September,” says Greenwich Associates consultant Dev Clifford. “If anything, these expectations for private equity and other asset classes might prove overly optimistic.”

Greenwich noted that declines in investment returns have produced a gap between pension funds’ actuarial earnings rate and their actual expectations for returns on plan assets.

For example, the average actuarial earnings rate reported by corporate pension plans increased modestly to 8.3 percent in 2008 from 8.2 percent in 2007, despite the decline in expected returns for all asset classes. The discrepancy results in an expected gap of 90 basis points.

The average actuarial rate for public plans declined to 8 percent in 2008 from 8.2 percent. However, the bigger drop in expected investment returns has produced a gap of 40 basis points.

“These gaps can only be made up in one of two ways: through higher investment returns or new contributions,” says Greenwich Associates consultant Chris McNickle. “At the present moment, neither option seems particularly likely. So we are facing a growing problem.”

A pension crisis threatens to become even worse over the next few years as companies, states, municipalities, and other plan sponsors face severe resource constraints. Greenwich points out that rather than being in a position to increase contributions, many plan sponsors are reducing or delaying contributions as a part of overall strategies to save money in the short term.