Funding ratios of US pension plans improved last year, but even with
several important factors working in their favor, investment performance
failed to meet the expectations of defined benefit plan sponsors, many
of which appear to be shoring up their plans with an eye toward
eventually winding them down.
Relatively strong market returns and a slight upward move in interest
rates contributed to an increase in average funding and solvency ratios
for corporate and public pension funds last year while propelling
endowment assets to a growth rate of 7.7%.
These improvements did little to allay concerns about the long-term health of US defined benefit plans, however. Rather, the results of 2005 provide a clear demonstration of plan sponsors’ need to wring ever higher levels of return out of their investment portfolios.
The new survey is based on the results of Greenwich Associates’ 2005
Investment Management research, in which 1,050 US institutional
investors, including 580 corporate pension plan sponsors, 225 public
plan sponsors, and 214 endowments, were interviewed.
“The strategies that plan sponsors are adopting are well thought out and
appropriate, including increased investment in international stocks and
certain alternative asset classes, and the growing use of absolute
return and portable alpha strategies,” says Greenwich Associates
consultant Dev Clifford.
“But thinking that shifting assets from US equities into these products will enable defined benefit plan sponsors to fund the bulk of their looming pension obligations through investment returns might be a case of hope triumphing over experience. What we might instead be witnessing is an effort on the part of corporate plan sponsors to get their pension houses in order before winding them down.”
For the typical large US defined benefit plan, the funding ratio on
accumulated benefit obligations increased from 95% at the start of 2004
to 99% at the beginning of 2005, while funding of projected benefit
obligations rose from 88% to 91%. Over the same period, the average
solvency ratio of public defined benefit plans increased from 87% to
89%.
These gains can be attributed in large part to three trends working in
pensions’ favor: strong returns from investment markets, positive net
contributions and rising interest rates that decreased the present value
of their future benefit obligations.
“Thanks to relatively robust markets and at least a slight decline in
future obligations, US pension plan sponsors made some progress last
year,” says Greenwich Associates consultant Rodger Smith, “but the
improvement in pensions’ health should not be overstated. Nearly a
quarter of corporate defined benefit funds still have projected benefit
obligations funded less than 85%.”
The modest gains achieved last year will do little to address the
demographic and economic problems that are driving many US corporate
plan sponsors to close their defined benefit plans to new employees and
even adjust benefits for existing workers and retirees.
The proportion of US corporate defined benefit plans closed to new employees increased from 19% in 2004 to 22%, and the largest plans appear to be closing at an accelerating rate. “The percentage of funds with assets of more than $5 billion that are closed to new employees increased from 13% in 2003 to 22% in 2005”, says Greenwich Associates consultant William Wechsler.
That said, pension plan sponsors are taking several ambitious steps to
improve their funding situations, including shifting assets into
international equities and alternative asset classes including hedge
funds, equity real estate, and private equity.
The final outcome of these moves remains to be seen, however.
“Based on the series of recent announcements from large companies – some
with healthy pension plans – that they are closing their plans to new
members, or freezing the plan altogether while turbo-charging their
defined contribution structures, it is not a stretch to assume that in
some cases, these alpha-generating strategies are being implemented by
plan sponsors to shore up their own plans in advance of a similar move,”
said Chris McNickle, a consultant at Greenwich Associates.