The funded status of U.S. corporate pension plans improved in 1994 for the first time in six years, according to a newly released study by Buck Consultants Inc.
But for 1995, despite the growth in pension assets from big investment gains in the stock market, falling interest rates have caused pension liabilities to rise sharply, making a further improvement unlikely, according to actuaries.
In fact, corporate plan sponsors might have to step up or resume contributions, even though funding improved in 1994, the actuaries noted.
The contrast of both years shows the powerful effect of interest rates movements on offsetting investment returns in the stock market, said Larry Wiltse, Buck consulting actuary and director of forecasting and planning services. While the stock market return in 1994 was one of the poorest in the past 15 years, the sharp rise in interest rates allowed corporate sponsors to sharply lower their pension liabilities by using higher assumed discount rates.
Now, Mr. Wiltse said, 1995 "is turning into the mirror image of 1994."
This year, "we're seeing a net growth in liabilities in excess of the return on assets," Mr. Wiltse added.
"We've had a decline in interest rates" in 1995 "and that's principally what affects the value of benefits," compared to return on assets.
"We'd probably expect little change in funding ratios in 1995," he said.
Gregory D. Hansen, principal at Towers Perrin, Chicago, noted, "A lot of companies are coming out of fully funded status and will have to make pension contributions again."
"You might see a slight decline in funded status in 1995," he added.
Because interest rates have fallen this year, both actuaries believe corporate sponsors will have to lower the discount rate they use for their pension plans, thus raising their pension liabilities.
"All of this is volatile," Mr. Wiltse said. "We've seen changes up and down in interest rates."
"On average things are in fairly good shape in pension funding," Mr. Wiltse said. "But that's the aggregate; people are concerned about their own plans."
The study of corporate pension plan financial health by New York-based Buck showed 1994 was the best year since 1988 for pension finances, reversing a steady decline in pension funding status.
The Buck study found 75% of the companies it surveyed had fully funded defined benefit plans in 1994, compared with only 60% in 1993. This percentage had steadily fallen each year from 95% in 1988. A fully funded plan is one that has sufficient assets to cover accrued benefit obligations.
The study was based on 1994 annual reports for 489 companies in the Fortune 1,000; the other companies in the Fortune group either have no defined benefit plans or no comparable data. In all, the 489 sponsors in the study had $616 billion in pension assets and $530 billion in accrued pension liabilities as of the end of 1994.
The study also found, on average, the adjusted funding ratios of pension plans increased to 122% in 1994 from 112% in 1993. The 122% indicated companies on average had 22% more assets than necessary to cover pension obligations. The average adjusted funded ratio also had declined steadily each year since 1988, when it was 167%.
What happened in 1994 to improve pension health? Mr. Wiltse asked rhetorically. "Interest rates went up significantly, about 160 basis points. That caused the present value of pension benefits to go down. On the asset side, pension funds on average had returns of -5% or zero" on their investments in the stock and bond markets. In 1994, the total return on the Standard & Poor's 500 Stock Index, including dividends reinvested, was a mere 1.31%, according to Ibbotson Associates Inc., Chicago. In the same year, long-term corporate bonds had a total return of -5.76% and long-term government bonds, -7.77%, according to Ibbotson.
"This year, interest rates have come back down by close to the same amount they went up in 1994," Mr. Wiltse added.
For the first nine months of this year, the total return of the S&P 500 was 29.7%, while long-term corporate bonds had a total return of 18.47% and long-term government bonds, 21.49%, according to Ibbotson.
"You probably need returns (in stock and bond investments) a little higher than that to offset the decline in interest rates," Mr. Wiltse added.
A decline in pension funding is worrisome, he added, "particularly if you are in a plan underfunded or with an employer that is not strong."
For 1995, "we expect employers to use dramatically lower discount rates than what they used" last year, Mr. Wiltse said.
In 1994, the median discount rate used by corporate sponsors was 7.5%, according to the Buck study.
Aside from interest rates, Mr. Wiltse noted other factors have caused pension funding status to deteriorate since 1988. They include suspension or reduction of pension contributions by fully funded plans, and the effects of corporate downsizing of the work force, causing unexpected large pension payouts to encourage early retirements.
In terms of investment policy, Mr. Wiltse said the results of the Buck studies on pension funding over the years show the importance of asset allocation. "In terms of time and effort, that's probably the most important place - focusing on investment policy," he said.