The deficit in pension plans sponsored by S&P 1500 companies increased by $86 billion in 2010, from a deficit of approximately $229 billion as of Dec. 31, 2009, to $315 billion as of Dec. 31, 2010, according to new figures from Mercer. This deficit corresponds to a funded status of 81% as of Dec. 31, 2010, compared to a funded status of 84% on Dec. 31, 2009.
The funded status of these plans could have been worse, Mercer claims, were it not for positive experience over the past 4 months of the year. In particular, December saw funded status improve by approximately $44 billion due primarily to positive equity returns.
For many companies, the larger deficit will drive higher P&L expense, as well as potentially significant increases in pension funding requirements, for 2011, as funding rules generally require sponsors to make up new deficits over 7 years.
Equity markets returned close to 7% during December, continuing their strong rebound for the second half of 2010. While the S&P 500 index returned 13% for the year, it has earned 22% since June 30, after falling 8% in the first half of the year. The strong returns combined with rising interest rates helped pension plan funded ratios rise close to levels seen at the beginning of the year, Mercer says.
We certainly saw a marked improvement in funded status over the past quarter, as equity returns and discount rates both moved favorably for plan sponsors, says Jonathan Barry, a partner with Mercers Retirement Risk and Finance consulting group. However, plan sponsors should remember the wide fluctuations in funded status that occurred through the year 2010 was a roller coaster ride for pension plans, with the aggregate funded status peaking at about 84% at the end of March, 2010, and hitting a low of 71% at the end of August actually lower than what we saw at the end of 2008 at the height of the financial meltdown.
The funded status deficit would have been worse if not for the estimated $43 billion that companies disclosed they expected to contribute during 2010. Many plan sponsors are merely treading water, or even moving backwards on funded status, despite significant cash contributions to their plans, Barry says.
The continued volatility associated with the level of interest rates and capital market exposure is of concern to pension plan sponsors as they seek to achieve prudent risk management. We continue to see a growing number of pension plan sponsors seeking to reduce the effect of defined benefit pension volatility on their balance sheets, says Kevin Armant, a principal with Mercers Financial Strategy Group. Dynamic asset allocation approaches that systematically reduce volatility as funded status improves are now commonplace. Many plan sponsors are engaged in detailed planning around the logistics of making lump-sum cash-outs available in 2012 as a means of reducing liabilities and we continue to see a lot of interest in exploring insurer buy-outs as a means of eliminating liabilities. If funded status continues to improve either through equity market performance or rising bond yields, 2011 could see a marked acceleration in the shift away from equities into bonds for corporate pension plans.