Companies that sponsor pension plans were sighing in relief at the end of 2013, when plans’ average funded status climbed to 89%, a 12-point gain from a year earlier and the highest level since 2007. That greatly lowered the sponsors’ future liabilities, allowing them to contribute far less to the plans last year than they’d been doing.
In 2014, when equity-market and long-bond values both spiked, pension plans enjoyed investment returns of about 9%. That, you may think, meant it was another great year for plans’ funded status.
But it wasn’t. Funded status fell to 80%, virtually the same level as in 2009, and the aggregate funding deficit grew by $181 billion. That gave back most of the previous year’s plan-funding gain, meaning plan costs will be much higher in 2015 than they were last year.
Does that make sense? It does. And the fact that it does provides the latest scary evidence of the dangers of pension sponsorship and why so many plans have been frozen or closed over the past two decades.
Fortune 1000 aggregate pension plan funding levels
There were two reasons the deficit swelled substantially despite the heady returns on fund investments: falling interest rates on long-term bonds and new mortality tables published by the Society of Actuaries in October, notes Towers Watson, which supplied the above data points. (The analysis encompasses the 411 Fortune 1000 companies that sponsor U.S. tax-qualified defined benefit pension plans and have a December fiscal-year-end date.)
The changes to the mortality tables — which factored in increased life expectancies, meaning pension benefits will be paid over a longer time period — are responsible for 40% of the expected funding-deficit increase, according to Towers Watson. That will push the average funded status down by 4% for 2015, says Dave Suchsland, a senior retirement consultant for the firm.
According to Suchsland, virtually the entire remaining 60% of the funding deficit is attributable to lower long-bond interest rates, which have an inverse relationship with bond prices.
“For a lot of plan sponsors it’s going to be frustrating that they made a lot of progress last year and now have to give it all back,” says Suchsland. “They’ve been making significant contributions to the plans since 2009 but are no better off now. Companies may have to rethink their perspectives on plan design, investment strategy, settlement options and funding policy.”
That pension funding levels could plummet during 2014, an outstanding year for both equity returns and long-bond returns, is telling. Equity gains, not including dividends, were 7.5% for the Dow Jones Industrial Average, 11.5% for the S&P 500, and 13.8% for the Nasdaq. Long bonds did even better: 25.1% for 30-year U.S. Treasuries and 17.4% for U.S. corporate bonds with at least 10-year maturities, according to Towers Watson.
“If you think about what’s happened over the last 20 years, with the shift from defined-benefit pension plans to defined-contribution plans, this year is a good example of why,” says Suchsland. “Great market returns, but the mortality update and the declining interest rates, which plan sponsors have no control over, made their position much worse.”
Still, he doesn’t think the increased funding deficit will push more companies to close or freeze their pension plans. “There was a significant after-effect to sharply decreased funding levels in 2002 and 2008,” Suchsland says, “but now, because the deficit is essentially the same as it was just two years ago, I don’t think we’ll see the same thing. Plan sponsors that have made the decision to continue to be in the pension business will continue to be in the pension business.”
Does the plunge in funded status give us any hint of what will happen in the future? “The only thing you can guarantee about the future is that plan sponsors will have higher costs in 2015,” says Suchsland.