Favorable returns on pension plan assets in 2014 could only partially offset the hit to median funding levels, according to analysis of 100 large corporate defined benefit plans by PwC.
Sharp decreases in interest rates from 2013 and more conservative mortality assumptions, which were widely adopted last year, brought the median funding level to 83 percent in 2014, down from 90 percent the previous year, and notably off the 100-percent median funding level posted in 2007, according to the investment bank’s 2015 Pension Disclosure Survey.
Nearly 45 companies were funded at 100 percent in 2007. Last year only six claimed that benchmark.
The Pension Protection Act of 2006 included aggressive new contribution requirements for underfunded plans, but those were offset somewhat by pension smoothing measures in the Moving Ahead for Progress in the 21st Century Act and the Highway and Transportation Funding Act of 2014, which set and extended interest rate corridors for estimating future liabilities, and had the effect of lowering contribution levels.
“Absent other changes in market conditions, for example, increasing interest rates or significant equity market returns, these funding levels will likely continue for some time,” wrote PwC analysts.
Sponsors took risk off the table in 2014, reducing median equity exposure to 38 percent of allocations, compared to 45 percent in 2014 and 64 percent in 2007.
Those assets were directed to fixed-income allocations, which accounted for 42 percent of median allocation in 2014, up from 35 percent in 2013. Last year marked the first time in at least the past seven years where median fixed-income allocations outstripped equity allocations.
The median discount rate in 2014 was 4 percent, down from 4.8 percent in 2013, and significantly lower than 2007’s 6.25 percent median rate.
Changes in discount rates since 2007 have been consistent with the overall movement of interest rates, according to the report.
Put in context, a defined benefit plan with $1 billion in obligations experiences about $120 million in new liabilities with an 80 basis point drop in the discount rate, the median decrease in 2014 from the prior year.
Sponsors also lowered their expectations for assumed returns on pension assets; reflective, in part, by the increasing shift of assets to lower-yielding fixed-income investments.
In 2014, median expected returns were forecast at 7.3 percent, a marginal decrease from 2013’s 7.5 percent expected median return, and a full 100 basis points lower than 2007’s expected return of 8.3 percent.
Lower expected returns directly increase sponsors’ annual contribution requirements, of course.
A hypothetical plan with $1 billion in assets would be required to contribute $2 million more from a 20 basis point decline in expected investment returns, as was experienced in 2014.
And a decline in expected returns of 100 basis points—the difference between 2014 and 2007’s return assumptions—means approximately a $10 million increase in annual pension expenses, or required contributions to plans, according to PwC’s report.