Largest corporate DB plans see no gains in funding

In a year when the nation's largest corporate defined benefit plans saw a 5.7% aggregate decrease in liabilities, funding levels barely budged. The culprit: a combination of low returns that hovered around zero and declining contributions for the third straight year.

The average funding ratio ended 2015 at 85.1%, down from 85.7% in 2014, even as the average discount rate increased 34 basis points to 4.39% in 2015, according to Pensions & Investments' annual analysis of SEC filings. The aggregate funding ratio also decreased to 82.1% from 82.7% the previous year.

Sixty-two of the 100 plans in P&I's universe reported a negative return on plan assets, with an average return of -0.31%.

Meanwhile, aggregate contributions by the plans in P&I's universe fell to $21.8 billion, from $28.4 billion in 2014, $31.7 billion in 2013 and $47.4 billion in 2012.

Dips in the funding ratio have not been accompanied by increased pension fund contributions since temporary federal funding relief lowered regulatory minimums by allowing companies to use higher interest rates to calculate liabilities.

“What we're seeing is that people are really taking advantage of the pension smoothing,” said Bob Collie, chief research strategist, Americas institutional, at Russell Investments in Seattle. Contributions made by large plan sponsors that the firm tracks in 2015 were not only insufficient to affect the funded status, they were too low to cover costs.

“The contributions were less than the value of the new benefits that have accrued,” he said.

Other industry observers viewed the relative stability in the funding ratios as a welcome development after a decade of volatility.

“The more plans have derisked the more they've been inoculated from market volatility,” said David Eichhorn, managing director, investment strategies, and a member of the investment committee at NISA Investment Advisors LLC in St. Louis. Although some plans have taken more action than others, overall, corporate DB plans are better protected against uncertain market returns and interest-rate risk than they were 10 years ago, he said.

Pension risk transfers continued in 2015, with firms offering lump sums or purchasing group annuities from insurance companies.

The average allocation to fixed income, which acts as a liability hedge, was 39.2% in 2015, up 11.7 percentage points from the 27.5% average allocation to fixed income in 2005.

In 2014, corporate plans had a 38.5% percent average allocation to fixed income.

Goodyear Tire & Rubber Co., Akron, Ohio, had the highest fixed-income allocation on P&I's list, with 89% of the plan's $5 billion in assets allocated to fixed income in 2015.

After freezing its plans for U.S. hourly workers and making a $1.2 billion contribution in 2014, Goodyear “changed its target asset allocation for these plans to a portfolio of substantially all fixed-income securities designed to offset the future impact of discount rate movements on the plans' funded status,” the company's 10-K said in 2014.

Goodyear had $5.34 billion in liabilities and a funding ratio of 93.9% in 2015, with allocations of 5.9% to private equity, 4.8% to cash, 0.2% to other investments and 0.1% to equities.

In 2015, 41 plans on P&I's list had fixed-income allocations of 40% or more.

Although not all plans have committed to a liability-driven investment strategy, Mr. Eichhorn said that, on average, most corporate plans have taken some action over the past decade to offset market volatility and interest rate changes.

“While risks remain, there have been meaningful steps over the past 10 years that have helped inoculate plans against volatility in the markets. Some plans are nearly fully insulated. They've basically derisked and they're at their end state,” Mr. Eichhorn said.

Other plans bet less on fixed-income holdings.

Weyerhaeuser Co., Federal Way, Wash., with more than 60% of its assets in hedge funds, had one of the highest returns for the year ended Dec. 31 at 4.1%, or $226 million, which helped bump up the plan's funding ratio to 88.4% from 84.2% in 2014.

With $3.44 billion of its $5.49 billion in assets allocated to hedge funds in 2015, Weyerhaeuser had the highest allocation to alternatives for the second consecutive year. The allocation to hedge funds increased 2.1 percentage points in 2015 to 62.6%. In addition to hedge funds, the plan allocated 23.1% to private equity, 13% to fixed income, 1.2% to real estate and 0.1% to equities.

Merck & Co. Inc., Kenilworth, N.J., had the most aggressive equity allocation in 2015 at 80.2%, including a 7.8% allocation to international equities. Assets dropped $226 million for the year, or a -2.44% return on its $9.27 billion portfolio. Despite the negative return, Merck's funding ratio rose to 95.3% in 2015 from 93.9% following a 60-basis-point rise in the discount rate to 4.8% that reduced liabilities to $9.72 billion from the previous year's $10.63 billion. Other asset allocations were 17.5% to fixed income, 2% to cash and 0.3% to other investments.

The aggregate allocation to equities in P&I's universe was 34.7% in 2015 vs. 35.8% in 2014; the overall allocation to alternatives increased to 18% from 16.8% the previous year; private equity declined to 5.8% from 6.3%; hedge funds for the top 100 plans increased slightly to 5.3% from 5.2%; real estate increased to 4.5% in 2015 from 3.9%; cash had the same 3.6% allocation in both years; and the allocation to other investments was 2.7% in 2015 vs. 2.6% in the previous year.

The average long-term assumed rate of return on plan assets also dropped in 2015. The average declined to 7.32% from 7.51% in 2014, 7.55% in 2013, 7.73% in 2012 and 7.94% in 2011.

Given the plans' long horizons, sponsors have time to meet their obligations, one expert said.

“We're talking about decades, many, many decades, before these (benefits) are to be paid out,” said Alan Glickstein, Dallas-based senior retirement consultant at Willis Towers Watson PLC.

Mr. Glickstein said volatile markets and more frequent revisions of actuarial assumptions mean annual reports should be considered a point-in-time measurement, rather than an absolute judgment of a plan's funded status.

NextEra Energy Inc., Juno Beach, Fla., had the highest funding ratio in 2015, at 148%, with $3.56 billion in assets and $2.41 billion in liabilities. Although the funding ratio dropped 1.63 percentage points from the previous year, 2015 was the company's 11th-straight year at the top of P&I's list.

Financial services companies made up the remaining four of the five highest-funded plans.

BB&T Corp., Winston-Salem, N.C., had the second-highest funding ratio at 126%. Assets rose 5% to $4.4 billion in 2015, but liabilities also increased 9% to $3.5 billion despite the plan's 41-basis-point discount rate increase to 4.68%.

Rounding out the top five, Bank of America Corp., New York, had a funding ratio of 124.2%, with $17.96 billion in assets and $14.46 billion in liabilities; J.P. Morgan Chase & Co., New York, 118.6%, with $14.13 billion in assets and $11.91 billion in liabilities; and The Bank of New York Mellon Corp., New York, at 112.3%, with $4.69 billion in assets and $4.18 billion in liabilities.

The continuing trend of pension risk transfer contributed to 2015's aggregate drop in assets and liabilities. Aggregate liabilities of the plans in P&I's universe decreased 5.65% to $1.367 trillion in 2015 from $1.449 trillion; aggregate assets fell by 6.39% to $1.122 trillion from $1.199 trillion in 2014.

Kimberly-Clark Corp., Dallas, contributed $410 million in 2015 and purchased group annuity contracts that transferred pension benefit obligations totaling $2.5 billion for about 21,000 U.S. retirees to Massachusetts Mutual Life Insurance Co. and Prudential Insurance Co. of America. At the end of 2015, Kimberly-Clark's pension liabilities dropped to $3.96 billion from $6.86 billion the previous year, plan assets were lowered to $3.51 billion from $5.91 billion, and the plan's funding ratio went up to 88.6% from 86.2%.

Also, J.C. Penney Co. Inc., Plano, Texas, offered a lump-sum window to about 31,000 retirees and beneficiaries in September 2015 and, a month later, purchased a group annuity contract from Prudential to transfer the pension obligations of about 43,000 retirees and beneficiaries. The plan's funding ratio dropped to 98.8% at the end of 2015 from 104.2% the previous year and plan assets fell to $3.29 billion from $5.47 billion. But the risk-transfer transactions lowered pension liabilities to $3.33 billion from $5.25 billion.

Plans that remain underfunded are facing increased premium payments to the Pension Benefit Guaranty Corp., said Justin Owens, Russell's Seattle-based senior asset allocation strategist. The Bipartisan Budget Act of 2015 raised variable-rate PBGC premiums to $30 per $1,000 of underfunding in 2016, up from $24 per $1,000 in 2015, with the premium eventually rising to $41 per $1,000 by 2019. As recently as 2013, the variable rate was $9 per $1,000 of underfunding. The fixed-rate premium of $64 per participant in 2016 will rise to $80 per participant in 2019. As recently as 2012, it was $35 per participant.

As higher PBGC premiums make underfunded status more expensive, Mr. Owens expects to see more sponsors take action to increase the funding ratio, including contributing more than the regulatory amounts. “People are being forced to re-evaluate that minimum-funding policy,” he said.

General Motors Co., Detroit, plans to contribute $2 billion to its U.S. hourly defined benefit plans by mid-2016, “which is expected to be financed by debt,” according to the company's 10-K. GM made $95 million in contributions during 2015 to its pension plans, which had $61.1 billion in assets and $71.5 billion in liabilities, for a funding ratio of 85.4% at the end of the year.

Mr. Owens said corporate strategies to increase contributions, including issuing new debt to take advantage of low interest rates, could be more cost effective than paying more to the PBGC.

“With the rising PBGC premiums, if the sponsor just pays the minimum requirement, in effect, it's a tax,” he said.

Only three companies contributed $1 billion or more in 2015, down from eight companies the previous year. Delta contributed $1.22 billion; United Parcel Service Inc., Atlanta, $1.16 billion; and Pfizer Inc., New York, contributed $1 billion in 2015.

Contributions made a difference for American International Group Inc., New York. AIG saw the highest funding ratio increase for the year, with a 10.61 percentage point jump to 81.87%. Plan assets had a negative return of $8 million, but with a 38-basis-point increase in the plan's discount rate to 4.32% and $558 million in contributions, liabilities decreased 8% in 2015 to $5.32 billion, and assets increased 6% to $4.36 billion.

In 2016, the plans in P&I's universe have announced $19.23 billion in expected contributions, a 33.4% increase compared with 2015's expected $14.42 billion.

The two lowest-funded plans on P&I's list each expect to contribute more than $1 billion in 2016.

Delta Air Lines Inc., Atlanta, plans to contribute $1 billion in 2016, including $500 million in discretionary contributions above its minimum-funding requirements. Delta's 45.5% funding ratio kept it at the bottom of P&I's list for the 11th-consecutive year, with $9.37 billion in assets and $20.61 billion in liabilities.

Exxon Mobil Corp., Irving, Texas, expects to contribute $2 billion in 2016. Exxon was the second-worst funded plan on the list, with a funding ratio of 56.1%. It had $10.99 billion in assets and $19.58 billion in liabilities at the end of 2015.

Going forward, AIG will use a different approach to determine pension interest costs, which the company's 10-K says will result in $52 million less in projected expenses for 2016. This new accounting method aligns the timing of the plan's discounted cash flows to the corresponding spot rates on a yield curve derived from the interest rates of investment-grade corporate bonds. n