Funded status hurt by longer lifespans, discount rate drop

The average funding ratio of the 100 largest U.S. corporate defined benefit plans dropped 7.7 percentage points in 2014 to 85.8%, despite strong investment returns that averaged 9.2%, Pensions & Investments' annual analysis of corporate SEC filings shows.

Revised mortality assumptions and a decrease in the average discount rate contributed to increased liabilities that offset asset returns. The data also showed a drop in expected corporate contributions for 2015, a surprise given the lower funding ratio.

Although aggregate assets of the top 100 plans increased to $1.199 trillion from $1.168 trillion in 2013, aggregate liabilities for P&I's universe rose to $1.45 trillion from $1.29 trillion.

The aggregate funding deficit of the largest 100 plans more than doubled to $249.9 billion from the previous year's deficit of $122.3 billion. The aggregate funding ratio fell 7.8 percentage points to 82.7% in 2014, from 90.5% in 2013.

“Even though funded status declined in 2014, we're seeing lower expected contributions in 2015, which is the opposite of what we've seen in past years,” said Justin Owens, senior asset allocation strategist at Russell Investments, Seattle.

The plans in P&I's universe have announced $14.42 billion in expected 2015 contributions, according to the annual filings, 32% less than the previous year's expected $21.09 billion in contributions.

“Sponsors are hoping a strong equity market or rise in the discount rate can help them save that cash,” said Andrew D. Wozniak, Pittsburgh-based head of fiduciary solutions for BNY Mellon Investment Management.

The Highway and Transportation Funding Act of 2014 reduced minimum required contributions by allowing plan sponsors to use a 25-year average interest rate to determine plan liabilities. However, increases to the required Pension Benefit Guaranty Corp. premiums could lead sponsors to make voluntary contributions above those required to raise funding levels and reduce future PBGC payments.

The impact of the higher premiums “is something that we've been expecting to see for a while and we're pretty sure we're going to start to see corporations say that PBGC premiums are affecting their funding policies. Once (premiums reach) the full level, we think that's going to affect funding policy,” said Bob Collie, Russell's chief research strategist, Americas institutional.

The plans in P&I's universe made contributions of $28.4 billion in 2014, down from $31.7 billion in 2013 and $47.4 billion in 2012. Eight companies contributed $1 billion or more in 2014: Exxon Mobil Corp., Irving, Texas; Goodyear Tire & Rubber Co., Akron, Ohio; Johnson & Johnson, New Brunswick, N.J.; Lockheed Martin Corp., Bethesda, Md.; Motorola Solutions Inc., Schaumburg, Ill.; Raytheon Co., Waltham, Mass.; United Parcel Service Inc., Atlanta; and Verizon Communications Inc., New York. Five companies contributed $1 billion or more during the previous year.

Contributions fell but actuarial liabilities rose, partly because of updated mortality tables and a new mortality projection scale released by the Society of Actuaries in 2014. The SOA revisions project increased life expectancy for Americans, which increases pension plan liability values and durations.

“People are living longer. We're seeing that all around us. Our goal is to provide a set of objective tables that plan sponsors can use as input into their liability studies,” said Dale Hall, managing director of research for the Society of Actuaries.

Not all plan sponsors adopted the changes in 2014, but integrating the SOA's updated mortality assumptions could eventually change the outlook on pension risk transfer.

Rising actuarial liabilities on the plan side could narrow the gap between the cost of pension liabilities on a corporate balance sheet and the cost of risk transfer, said Alan Glickstein, Dallas-based senior retirement consultant at Towers Watson & Co. “It does shift the equation in a way that makes those settlement options more appealing. It makes the price you pay an insurance company to annuitize that much better” because it brings plans' liability assumptions closer to the longevity assumptions and estimated liability costs insurance companies that sell risk transfer use to set prices, Mr. Glickstein said.

The potential for future risk transfers might already have affected some asset allocation choices. Although the aggregate allocation to cash modestly increased half a percentage point in 2014, rising to 3.6% from 3.1% in 2013, some plans became significantly more liquid in 2014.

MetLife Inc., New York, increased its allocation to money market securities and short-term investments 6.1 percentage points to 6.3% in 2014 from 0.2% the previous year. Allstate Corp., Northbrook, Ill., increased cash and short-term investments 5.5 percentage points to 5.9% from 0.4%. Verizon increased cash and cash equivalents 5 percentage points to 10.7% from 5.7%. Marsh & McLennan Cos. Inc., New York, added a 4.9% allocation to short-term investment funds.

“A lot of the sponsors are staying liquid in case they decide on lump sum or partial or full terminations in the next few years. Liquid alts or absolute return are options,” said BNY Mellon's Mr. Wozniak.

With its pension plan frozen and a funding ratio of 120%, Bank of America Corp., New York, had 15.8%, or $2.9 billion, of its $18.6 billion in plan assets allocated to cash and short-term investments, up from 11.9% in 2013.

“If it's a frozen pension plan, they are more likely to stay liquid. It's difficult to wrap up a 10-year private equity commitment” if you need money for a risk transfer, Mr. Wozniak said.

In addition to increased longevity assumptions, the discount rate decrease to an average of 4.05% in 2014 contributed to the lower average funding ratio. Only six plans in P&I's universe increased their funded status in 2014, whereas 97 plans increased their funded status in 2013 when the discount rate average was 4.82%.

“If the discount rate would have remained constant, the funding ratios would have remained exactly where they started,” Mr. Wozniak said.

Only 11 plans had a funding surplus in 2014, while 24 plans in P&I's universe had a funding surplus the previous year.

The highest funding ratio — 149.6% — once again was held by NextEra Energy Inc., Juno Beach, Fla. NextEra's pension fund assets saw a slight increase to $3.698 billion in 2014 from $3.692 billion the previous year, while the discount rate it used in 2014 dropped to 4% from 4.8% and liabilities increased to $2.5 billion from $2.3 billion.

MeadWestvaco Corp., Richmond, Va., had the next highest funding ratio at 149.3%. Assets rose to $4.1 billion in 2014, from $3.9 billion in 2013. Liabilities increased to $2.8 billion in 2014 from $2.4 billion.

The remainder of the five highest-funded plans were financial services companies. BB&T Corp., Winston-Salem, N.C., had a funding ratio of 130.9%, with $4.2 billion in assets and $3.2 billion in liabilities; Bank of America Corp., 120%, with $18.6 billion in assets, $15.5 billion in liabilities; and J.P. Morgan Chase & Co., New York, 116.6%, with $14.6 billion in assets and $12.5 billion in liabilities.

Goodyear Tire & Rubber Co., Akron, Ohio, with $6.25 billion in assets and $6.5 billion in liabilities, had the highest jump in funded status, rising almost 16 percentage points to a funding ratio of 96.1% in 2014 from 80.3% in 2013.

According to its 10-K, Goodyear made $1.167 billion in contributions, “including discretionary contributions of $907 million, to fully fund our hourly U.S. pension plans.” Goodyear froze future accruals for hourly U.S. plans effective April 30, 2014, and shifted the plans' target allocation to 90% fixed income, 6% equities and 4% cash, from 55% fixed income, 41% equities, 3% cash and 1% alternatives. The move to fixed income was designed to “offset the future impact of discount rate movements on the plans' funded status,” the 10-K said.

Fixed income had the largest aggregate allocation in P&I's universe at 41.3%, 2.9 percentage points higher than the previous year. However, as Towers Watson's Mr. Glickstein notes, not every plan is moving to liability-driven investing.

“There's no magic answer that's right for everyone. As we've seen, rates can move around and assets can move around,” he said.

The aggregate allocation to hedge funds for the top 100 plans increased almost a full percentage point to 5.2%, from 4.3% in 2013.

Weyerhaeuser Co., Federal Way, Wash., with a funding ratio of 84.2%, allocated 60.5% of its $5.6 billion in assets, or $3.4 billion, to hedge funds in 2014.

The aggregate allocation to equities was 35.8% in 2014 vs. 37.6% in 2013.

The aggregate allocation to private equity declined slightly to 6.3% from 6.4%, while the aggregate allocation to real estate dropped to 3.9% from 4.4%.

The allocations to other alternatives was 1.3% vs. 1.1%; and other investments, 2.6% vs. 4.7%.

The Barclays U.S. Long Government index returned 19.3% for the year; the S&P 500 index gained 13.69%; Russell 3000 index, 12.44%; Barclays Government/Credit index, 6.01%; and Citigroup Non-U.S. World Government Bond index, -2.68%.

Despite the strong performance of equity markets and U.S. long-term government bonds, the average long-term assumed rate of return on plan assets continued to slide in 2014. The average declined to 7.51% from 7.55% in 2013, 7.73% in 2012 and 7.94% in 2011.