Corporate defined benefit pension plans are likely to lower their expected rate of return assumptions if large public plans continue to do the same, according to a recent study.
“We suspect that as more public plans reduce this assumption ... increasing pressure will be placed on corporate plans to lower their assumptions, too,” the study said.
According to the study, “2011 Pension Preview: Challenges and Changes,” many public DB plans have been lowering their return assumptions recently, often to less than 8%.
Among the examples of public plans cited are the $220.3 billion California Public Employees' Retirement System, Sacramento, which currently has an expected return of 7.75% but could be reduced to as low as 7.38% for 2011-2014 (Pensions & Investments, Dec. 27), and the $51.9 billion Virginia Retirement System, Richmond, which has an expected return of 7%.
Yet according to the study released earlier this month by Goldman Sachs Group Inc.'s Global Markets Institute, New York, the average expected return for U.S. corporate DB plans with at least $1 billion in assets was 8.25% during 2009, while the average expected assumption for the U.S. plans of all S&P companies during the same year was 8%.
In an interview, Michael A. Moran, a Global Markets Institute vice president and the study's co-author, said public plans are likely to be lowering return assumptions in response to expectations of lower long-term asset returns.
Also according to Mr. Moran, corporate plans have an incentive to keep their return assumptions “as high as possible as it lowers recognized pension expense.”
“Many public plans now have lower return assumptions than corporate plans, even though public plans have greater exposures to equities and alternative asset classes than corporate plans do,” Mr. Moran said.
The study also predicts that corporate DB plans will continue shifting toward liability-driven investment strategies — a trend that the study says has been spurred largely by the adoption of stricter accounting and plan funding regulations over the past several years.
“From 2004 through 2007, a period of rising share prices, the asset-weighted allocation to equities (of the U.S. plans of S&P 500 companies) declined to 56% from 64%,” the study said. “By the end of 2009, the actual allocation (to equities) had fallen to 48%, which was almost exactly in line with the target allocation for these plans,” the study continued.
“Future accounting rule changes that are currently in progress ... will likely provide even greater incentive for plans to increase allocations to fixed income, especially as funded status improves over time, in an effort to minimize funded status volatility,” the study said.
The study also says that that low interest rates are continuing to depress funding levels of plans.
“This is the downside of low interest rates,” the study said.