Corporate pension plans underfunded despite record gains

The funded status of the largest US corporate pension plans hardly changed last year, despite the strongest investment gains since 2003, an analysis by Willis Towers Watson has found.

The analysis examined pension plan data for 376 Fortune 1000 companies that sponsor US-defined benefit pension plans and have a December fiscal year-end date.

Results indicate that the aggregate pension funded status is estimated to be 87% at the end of 2019, compared with 86% at the end of 2018.

Employer-sponsored defined-benefit plans calculate employee retirement benefits based on length of employment, salary history and other factors.

Because the employer bears the risk that investment returns will not cover the defined benefit due to the retired employee, the plans are complex and expensive to manage. Even before the financial crisis in 2008, many defined-benefit plans found themselves underfunded and large corporate schemes like IBM, Lockheed Martin, Motorola and Verizon announced they would stop funding their plans.

The projected pension deficit of $216 billion at the end of 2019 is slightly lower than the $222 billion deficit at the end of 2018. Pension obligations increased 9% from $1.58 trillion in 2018 to an estimated $1.72 trillion in 2019.

Historically low interest rates mostly offset the strong overall investments gains that were estimated to have averaged 19.8% in 2019. Firms have to use current interest rates to determine the value of future benefits, with lower interest rates resulting in larger liabilities and additional contributions.

“Significant gains experienced in both the stock and bond markets should have bolstered the financial health of corporate pension plans in 2019,” said Joseph Gamzon, senior director, retirement at Willis Towers Watson. “However, interest rates were at historically low levels and experienced the largest one-year drop in two decades, resulting in a huge increase in plan obligations and little overall change in the plans’ funded status.”

The returns of asset classes varied in 2019. Domestic large-capitalisation equities grew 32%, while domestic small/mid-capitalisation equities realised gains of 28%. Aggregate bonds saw gains of 9%, while long corporate and long government bonds, typically used in liability-driven investing strategies, returned 23% and 15%, respectively.

“2019 was a year of extremes, with historically low interest rates and high investment returns,” said Jennifer Lewis, senior director, retirement at Willis Towers Watson. “As we move into 2020, these conditions will cause employers to face growing pressure on their plans’ expected rate of return assumptions at the same time as they prepare for higher required cash contributions due to the upcoming expiration of pension funding relief.”

She said sponsors would want to keep an eye on interest rates as increases from their current low levels could create “opportunities to re-evaluate their investment strategies and consider a range of risk reduction options”.

The analysed companies contributed an estimated $26.3 billion to their plans in 2019 – roughly half of what they contributed in 2018, when many plan sponsors took advantage of the higher tax deductions for pension contributions that existed before the Tax Cuts and Jobs Act of 2017. This larger deduction is no longer available to plan sponsors.

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