Pension plans funding back to near 100%Posted On: Apr. 15, 2007 12:00 AM CST
Funding levels of large U.S. pension plans, aided by several years of stellar investment results, are improving dramatically, with plans, on average, now nearly fully funded.
Defined benefit plans offered by 100 very large U.S. employers were, on average, 99.7% funded in 2006, up from 91.4% in 2005 and 89.9% in 2004, according to a survey released last week by Seattle-based pension and actuarial consultant Milliman Inc.
The funded ratio improvement was largely the result of a 12.8% average return on plan assets, significantly higher than the 8.4% rate of return employers had been expecting.
In fact, last year marked the fourth consecutive year that average investment returns were in double digits. Investment gains averaged 11.3% in 2005, 12.4% in 2004 and 19.2% in 2003.
Those consistent, large investment returns helped push the average funded ratio of those pension plans near 100%--the highest level since 2001, when plans, on average, were 102.2% funded.
"The lead story is the improvement in funded status," said John Ehrhardt, a Milliman consulting actuary in New York. "The losses we saw in 2001 and 2002 have almost been completely reversed and the health of America's defined benefit pension plans significantly improved.
Still, even with the big improvement in funding, many pension plans have a long way to go before reaching the funding levels of the late 1990s, when the bull equities market drove up the value of plan assets.
In 1999, just before the last bull market came to an end, surveyed employers' plans were, on average, 130.4% funded. But starting in 2000, plans' average funding levels--hurt first by mediocre investment results and then by investment losses--began falling sharply and reached their nadir of 82.7% in 2002.
The survey findings are based on an analysis of 100 large public U.S. corporations in the Standard & Poor's 500 Index that had the largest defined benefit plan programs as measured by total plan assets and had annual financial reports available as of March 15.
The pension programs of the surveyed employers include qualified and nonqualified U.S. plans and foreign plans. Nonqualified and foreign plans are subject to much lower funding requirements than qualified U.S. plans, if they are subject to any funding requirements at all. Indeed, if nonqualified and foreign plans were excluded, most employers' pension programs would be fully funded, Milliman actuaries say.
Aside from strong 2006 investment returns, the rise in interest rates also helped pension plan funding since they reduced plan liabilities. Higher interest rates allow employers to assume a smaller amount of money will be needed to cover a future obligation.
The survey, though, affirms the volatility of investment results.
For example, the double-digit annual investment returns over the last few years contrasts with just a 4.8% average return on assets in 2000 and average losses of 7.1% in 2001 and 8.8% in 2002.
The improvement in pension plan funding is triggering several corporate responses, Mr. Ehrhardt said. For example, some companies are trying to lock in their investment gains by shifting more plan assets into fixed income instruments.
While that may mean employers could forgo some investment gains if equities continue to sparkle, such an investment strategy reduces the likelihood of plan assets tumbling in the event that the stock market crashes, forcing employers to step up contributions to their plans.
Additionally, the improvement in plan funding, and other factors, could mean fewer employers are likely to freeze their defined benefit plans in favor of enhanced 401(k) plans. Instead, more employers may convert traditional plans into hybrids such as cash balance plans, according to the survey.
"The recent trend of freezing defined benefit plans may be reversed as companies realize that a defined benefit plan is a valuable tool to attract and retain employees in a shrinking employment market," the survey said.
About 15 of the surveyed employers have frozen at least one of their defined benefit plans, said Adrien LaBombarde, a consulting actuary in Milliman's Houston office.
Detroit-based General Motors Corp. had the biggest defined benefit plan, as measured by assets, among surveyed employers. Last year, GM's plans had $112.9 billion in assets and its defined benefit plans were 104.6% funded--a big improvement from 2005, when GM's plans were 95.8% funded.
Pension plans sponsored by IBM Corp. of Armonk, N.Y., had $90.5 billion in assets in 2006 and a funded ratio of 104.6%. That also was significantly better than 2005's pension program funding of 96.3%.
The survey, "Milliman 2007 Pension Funding Study," is available at www.milliman.com.