Equity Declines Hurt US Plan Sponsors In 2008, Watson Wyatt

A Watson Wyatt analysis of pension disclosures for the 100 U.S. pension sponsors has found that aggregate funding fell by $303 billion last year, going from an $86 billion surplus at the end of 2007 to a $217 billion deficit

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A Watson Wyatt analysis of pension disclosures for the 100 U.S. pension sponsors has found that aggregate funding fell by $303 billion last year, going from an $86 billion surplus at the end of 2007 to a $217 billion deficit at the end of 2008. Overall, aggregate funding levels decreased by 30 percentage points, from 109% funded at the end of 2007 to 79% funded by the end of 2008.

According to the analysis, pension contributions increased slightly last year — from $17.7 billion in 2007 to $18.4 billion in 2008. However, companies are expecting to make substantially larger contributions in 2009, up to more than $27.7 billion — a 50% increase over 2008 cash contributions. As many firms will not need to make their required contributions until 2010, this increase can be attributed to companies’ making payments now to shore up funds in anticipation of future requirements.

Pension plan assets declined by 26% in 2008, largely due to significant equity losses. The percentage of a plan’s portfolio invested in equities had a direct relationship with investment losses in 2008 — plans that had less than 20% of their portfolio in equities lost an average of 6%, while those with an equity allocation of 55% to 59.9% lost 23.6%. Those with an equity allocation of 90% or more lost 32.3%.

While stated equity targets have not declined significantly, actual equity allocations at year end were much lower. For the 83 companies that provided data, the average target equity allocation is 55% for 2009, compared with 58% for 2008.

However, actual equity allocations fell over the year, to 48% at the end of 2008 from 59% the year before. Rather than a strategy shift, this reallocation was mostly due to the significant drop in the stock market — bonds significantly outperformed equities, thereby automatically shifting funds’ asset distribution. It remains to be seen whether plans will redress this imbalance.

“Plan sponsors were hit hard with a double whammy in 2008 with severe market declines and new funding rules coming into effect,” says David Speier, senior retirement consultant, Watson Wyatt. “This combination will require employers to make staggering pension contributions over the next couple of years, at a time when they can least afford them.”

“Many pension plan sponsors have remained committed to equity investments as they have been expected to provide the best long-term returns,” says Carl Hess, global head of investment consulting, Watson Wyatt.

“However, the recent financial turmoil shows that large equity positions can create substantial risks. Companies can alleviate some of this risk by adopting liability-driven investment strategies, which utilize bond and derivative markets to better hedge their long-term pension liabilities, while at the same time making sure the overall risk level in their portfolio is one they can live with.”

L.D.

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