Pension funding dropped even further in 2012, despite the efforts of plan sponsors who contributed more to their plans in an attempt to bridge their funding gaps.
According to new research by Towers Watson, the funded status of pension plans at 429 of the Fortune 1000 companies ended the year at 75 percent, compared to 78 percent at the end of 2011.
Overall, pension funding decreased by $79 billion last year, leaving a deficit of $418 billion at the end of 2012.
All signs had pointed to a better year for pension funding, and based on historical data, pensions should be making a push back up to 100 percent funded, said Alan Glickstein, senior retirement consultant with Towers Watson, but that didn’t happen.
In the past, looking back over 25 years of data, the economy would take a rapid dive, like during the Great Recession, and then recover back to where it was over a five-year period.
“This is looking different. We are three or four years out from the recession and we’re moving in the wrong direction,” he said. “It is a bit of a break with past history, which raises the question whether this is the new normal. Are we having a bit of a disruption in normal getting back to 100 percent or is something else going on?”
So what happened? Because of the federal government’s attempts to keep the economy out of recession, interest rates are at historic lows, which drove pension liabilities up, Glickstein said. This was surprising to a lot of people because investments saw double-digit returns and most plan sponsors built in hefty contributions to their plans in 2012 to try and bring their funded level back up to a higher level and pensions still went the wrong direction, he said.
It becomes a Catch-22 for plan sponsors who desperately want to keep their fiscal houses in order and fund their pension plans as much as possible, but it is a delicate balance.
Many people believe that pension liabilities shouldn’t be calculated using the artificially low interest rates that exist currently and “don’t represent the benchmark they want to assess the health of their pension plans,” he said.
Many plan sponsors also took advantage of a funding relief measure that allowed them to contribute even less than they have in the past to their pension plans. With that came a higher premium to the Pension Benefit Guaranty Corporation. “If actual contribution levels end up reflecting significant use of funding relief, funded status could be 1 or 2 percentage points worse than estimated,” according to Towers Watson research.
Pension plan asset s increased by an estimated 4 percent in 2012, from $1.218 billion at the end of 2011 to an estimated $1.266 billion at the end of 2012.
Rates are not expected to increase any time soon, Glickstein said. “It is hard to say, but what we do know for sure is the government is publicly taking steps to lower these rates beyond where they would be by the actions they are taking,” he said. “Whenever those actions are changed—it will continue for a few more years—those rates will rise.”
The uncertainty of the situation makes it hard to estimate what will happen to pension plans in 2013, Glickstein said. He believes the rates will probably stay where they are. “There is no reason to think they are going up. It is not inconceivable to think they could go down from here,” he said.
Since 2007, there has been a steady movement of plan sponsors freezing or closing down their pension plans. This movement was driven by the financial volatility the current market has had on pension plans. Glickstein doesn’t believe the rate of closures and frozen plans will increase beyond what it has been because most of the employers who were considering such a move have already started the process, he said.
Many employers still “value pension plans and continue to have them.”
He added that just because a plan decides to freeze or close its plan doesn’t change its assets in the short-term. It doesn’t change the management of the plan or the challenges the plan faces.
In 2012, there were some well-publicized decisions on the part of plan sponsors to purchase annuities to shift the obligation from the plan sponsor and the government standing behind the plan sponsor to insurance companies and shrinking the size of the plan faster than it normally would shrink, he said. Other plan sponsors have offered retirees lump sum payments instead to better manage the funding gap.
There will be continued interest in all three options in 2013, Glickstein said.
When Towers Watson works with clients, each one is different. They start at the organizational level asking numerous questions, including: Do you have cash on hand? How much should you put into the business? What are the tax issues? Can you borrow at rates that allow you to put more money into the plan? Can you take action to make the plan smaller or adjust your profile to lower your liabilities?
“These all factor into the basic decision about how [a plan sponsor] feels about its funded status,” Glickstein said. “Do we have a fairly large gap we need to make up with our own contributions over time or are the numbers reported not fairly representing the situation as it is?”
With interest rates as low as they are it would be very easy to overfund a plan. The situation could turn around as quickly as it went south, he said, and if that happens, some plans could be 100 to 120 percent funded. Because of that, there’s a disincentive to bring plans up to 100 percent funded status, he said.
There is a movement toward defined contribution plans instead of pension plans but, as Glickstein points out, DC plans are experiencing some of the same problems as pension plans.
In 401(k) plans the risks have shifted to the workers instead of being in a professionally managed pension plan.
“Those haven’t worked out super well as a primary retirement vehicle. We’ve seen a lot of workers not achieve what they needed to, to retire,” he said.
Eventually, the government will have to have a serious conversation about the most efficient ways to transition from working to not working, he said. That will include pensions, defined contribution plans and Social Security.
“We haven’t had a retirement-related policy discussion in this country in a long time. Maybe it will not happen in 2013, but it needs to happen sooner rather than later,” Glickstein said.