SANTA MONICA, Calif. Higher returns boosted the 2006 funding ratio of defined benefit plans sponsored by companies in the Standard & Poors 500 index, a new study from Wilshire Consulting shows.
Most plans remained underfunded, but high investment returns are stoking a debate over whether plans should increase their fixed-income allocations to minimize the plans sensitivity to changing interest rates.
The funded status of the 330 companies in the S&P 500 that sponsor defined benefit increased to 101% in 2006, from 93% the year before turning an $83.5 billion deficit into a $16.6 billion surplus. However, 29% of the pension funds had assets that equaled or exceeded their liabilities last year, up from 17% the year and a low of 11% in 2002.
There are many more plans this year that are back in the black, said Steve Foresti, a managing director at Wilshire in Santa Monica, Calif. Its been a fantastic environment for funded levels this year.
As companies found their pension plans on more solid footing, contributions decreased, dipping to $35.3 billion in 2006 from $46.3 billion a year earlier.
Pension funding ratios were helped by higher interest rates, which lowered the value of present liabilities, as well as by a fourth consecutive year of strong investment returns.
The median investment return was 11.5% in 2006, up from 8.5% in 2005 and 10.8% in 2004. Those returns have some pension executives worrying less about managing short-term volatility with higher fixed-income allocations, opting instead to chase higher returns in the equity market, Mr. Foresti said.
Risk has two sides, its not just downside, Mr. Foresti said. With four positive years in the market and that funded ratio improving, I think many corporate plans have been reminded that as long-term investors, some of the short-term volatility can be sustained within reason.
Effects of law
Some pension consultants and actuaries have predicted that the Pension Protection Act and upcoming changes to pension accounting rules will lead plans to increase their allocations to fixed income. General Motors Corp., Detroit, moved an additional 20% of its pension assets to fixed income from global equity last month. That type of shift matches assets and liabilities more closely and minimizes a plans sensitivity to changing interest rates.
Some of the larger, well-funded plans might make such shifts, Mr. Foresti said, but he notes that most S&P 500 companies still have underfunded plans and could benefit from leaving some risk on the table and getting more return from the equity market.
People might prematurely abandon a 60/40 asset mix thinking theyre locking things up now, but thats not the case, added Brian Ternoey, the investment practice head at investment consulting firm Curcio Webb, Pennington, N.J. The interest rate is not the only thing affecting liabilities. Issues such as longer life expectancy and salary raises can also increase liabilities, and plan executives would benefit from keeping their equity allocations to fund those changes, Mr. Ternoey suggested.
The median corporate funded level of plans for S&P 500 companies was 120% in 1999, which translated into a $295 billion surplus, according to the Wilshire report.
And Mr. Ternoey said it is important for companies to remember lessons from the late 90s. At that time, many plans offered increased benefits for employees that were too expensive to fund.
The biggest thing to do this time is to resist that temptation to use any surplus, Mr. Ternoey said. Thats more important than immunizing the liabilities.