TW Pension 100: Year-End 2014 Disclosures of Funding, Discount Rates, Asset Allocations and Contributions
April 14, 2015 - Towers Watson
At a Glance
-
Falling interest rates coupled with updated
mortality assumptions significantly increased liabilities, thus wiping out
most of the previous yearfs gains.
-
Average funded status was 82.2% at year-end 2014,
down considerably from 90.2% for 2013 but still up from 77.1% for
2012.
-
Plan sponsors using liability-driven investment
strategies had good results in 2014.
During 2014, aggregate funded status1
for defined benefit (DB) plans in the Towers Watson Pension 100 (TW Pension
100)2
fell from 89% to 81%. While plan assets gained value, falling interest rates
coupled with updated mortality assumptions3
significantly increased liabilities, thus wiping out most of the previous yearfs
gains.
This annual analysis is based on just-reported pension disclosures from the
Securities and Exchange Commission 10-K filings of 100 publicly traded U.S.
sponsors of large pension plans whose fiscal years end in December.4
We examine reported funding results, the discount rates used to measure
liabilities, the effect of new mortality assumptions on the projected benefit
obligation (PBO), target asset allocation policy for 2015, return on investment
and sponsorsf 2014 contributions. Where applicable, historical values shown are
for companies in the 2014 TW Pension 100.
Funded status weakens and overall deficit climbs again in 2014
The gap between liabilities and assets veered from an $82 billion surplus in
2007 to a record-high $297 billion shortfall at year-end 2012 (Figure
1). During 2013, assets grew, interest rates rose (for the first time in
four years) and plan obligations declined accordingly, thus reducing the funding
shortfall from $297 billion in 2012 to $128 billion in 2013. By year-end 2014,
however, the aggregate pension deficit for the TW Pension 100 was back up to
$248 billion; sponsors are not yet out of the funding hole dug by the 2008
financial crisis. There have been some net gains since year-end 2008: Aggregate
liabilities are up by 40%, while aggregate assets are up by 44%.
Assets in the TW Pension 100 plans grew by 3% over 2014, while plan
obligations rose by 13%.5
Investment returns were higher than expected and sponsors made relatively large
plan contributions (albeit smaller than those in prior years).
The pension deficit increased from $127.9 billion in 2013 to $248.2 billion
in 2014 — an increase of $120.3 billion or 94% — close to double the previous
yearfs deficit.
Figure 1. Aggregate year-end
funded status for TW Pension 100 ($ billions), 2007 – 2014
Source: Towers Watson
Average funded status for the TW Pension 100 was 82.2% at year-end 2014, down
considerably from 90.2% for 2013 but still up from 77.1% for 2012 (Figure
2). For the second year running, average funded status was slightly higher
than aggregate funded status, indicating that plan funding was slightly lower
among the largest of these DB plans.
Figure 2. Funded status (%) for TW Pension 100, 2007 – 2014
Source: Towers Watson
Figure 3 depicts the distribution of funded status since 2007 and
shows some major shifts. At year-end 2014, funded status was 80% or more for 56
of these programs (100% or more for six of those). At year-end 2013, funding
levels were 80% or higher for 81 programs (100% or more for 19 of those). Just
before the financial crisis, more than half the TW Pension 100 had fully funded
pensions.
Figure 3. Distribution of funded status for TW Pension 100, 2007 –
2014
Source: Towers Watson
Figure 4 shows changes in funded status from the 2013 to the 2014
plan year. Funded status increased for seven plan sponsors and declined for the
other 93, with the decline typically between 5% and 9.9%.
Figure 4. Changes in funded status for TW Pension 100, 2013
– 2014
Source: Towers Watson
Discount rates fall back to 2012 levels
Plan obligations rose in 2014 mainly because of lower interest rates. From
2008 through 2012, discount rates fell every year, before finally rising in 2013
(Figure 5). Then in 2014, the average discount rate fell by 83 basis
points — from 4.85% to 4.02%, thereby increasing pension liabilities by
10%. At year-end 2014, the average discount rate was 236 basis points lower than
it was in 2008.
Figure 5. Average year-end discount rate assumptions for TW Pension
100, 2007 – 2014
Source: Towers Watson
New mortality tables push liabilities even higher
During 2014, one-time improvements in mortality assumptions played a
significant role in driving up pension liabilities. The Society of Actuaries
(SOA) published updated mortality tables and a new mortality projection scale in
October 2014. The updates reflect historical and projected longevity
improvements among workers, which increase the number of years employers have to
pay out benefits in the future. The vast majority of plan sponsors updated their
mortality assumptions (in a variety of ways) at the end of 2014, which increased
aggregate PBO for the TW Pension 100 by 4.3% or $55 billion.6
Sponsors continue shifting to fixed-income allocations
For several years now, many plan sponsors have been gradually reducing their
investment risk by shifting asset allocations from public equities to
fixed-income and alternative investments (Figure 6).7
Since 2009, average allocations to public equities have fallen by 13 percentage
points, while allocations to fixed-income investments have risen by nine
percentage points.
Of the 94 companies that reported target asset allocation strategies for 2014
and 2015, nine reduced their target equity allocations by five percentage points
or more, with an average reduction of 13 percentage points. On the other hand,
six sponsors upped their exposure to equity by five percentage points or more,
with an average increase of eight percentage points.
Figure 6. Average target asset allocation percentages for TW Pension
100, 2009 – 2015
Source: Towers Watson
For 2015, aggregate results (weighted by plan assets) differ from average
results, which also occurred in earlier analyses. On an aggregate level,
sponsors hold less public equity, and more debt and alternative investments,
indicating that the largest TW Pension 100 plans have more fixed-income and
alternative investments than the smallest (relatively speaking) of these large
plans.
Investment returns were positive, especially for fixed-income holdings
During 2014, investment returns varied significantly by asset class. Equity
markets were good and bond returns were very strong, especially for long
corporate and Treasury bonds. At year-end 2014, both aggregate returns (weighted
by plan assets) and average returns exceeded expectations at 9.7% and 9.8%,
respectively (Figure 7).8
Plan sponsors using liability-driven investment (LDI) strategies had good
results in 2014, as long bond returns offset declining interest rates.9
Long government and long corporate bonds realized returns of 26% and 15%,
respectively. Twenty-nine of these pension sponsors had target fixed-income
holdings of 50% or more going into 2015, and the average 2014 return for this
group was 12.3%. For companies holding more than 60% in debt, the average return
was 14.2%. On the other side of the spectrum, the average 2014 return for the 25
companies with less than 30% targeted to fixed-income assets was 7.4%.
Figure 7. Investment returns for TW Pension 100, 2008 – 2014
Source: Towers Watson
While many factors other than investment returns affect funded status, it is
interesting that six of the seven companies whose funded status improved in 2014
had fixed-income allocations of 50% or more going into 2015. While these plans
might have missed out on the strong equity gains in 2013, their fixed-income
allocations were able to offset the effects of falling discount rates in 2014.
To further illustrate the hedging effects of liability-driven investing in a
declining interest rate environment, we look at the relationship between asset
growth (aggregate investment returns) and movements in PBO due to changing
interest rates (actuarial gain/loss), as well as the expected growth in
liabilities due to the passage of time during the year (interest cost), based on
sponsorsf fixed-income allocations (Figure 8).
Those with 70% or more in debt had investment returns of $10.5 billion —
offsetting their $10.4 billion increase in liabilities due to interest rate
changes and interest cost. The correlation between asset returns and liability
growth weakens as the percentage in fixed-income asset holdings declines. Plans
with less than 30% in fixed income (and large public equity and alternative
investment holdings) had investment returns of $12.8 billion, not enough to
offset the $33.9 billion increase in liabilities due to interest.
Figure 8. Aggregate investment returns versus liability increases ($
billions), 2014
Source: Towers Watson
Employer contributions lowest since 2008
Companies made relatively large contributions to their DB plans for 2014,
albeit not as large as in prior years (Figure 9). The 2012 Moving Ahead
for Progress in the 21st Century Act (MAP-21) and the 2014 Highway and
Transportation Funding Act allowed sponsors to significantly reduce minimum
required contributions starting with the 2012 plan year (by using a long-term
average discount rate, which is much higher than what is otherwise required).
Many sponsors appear to have opted for the funding relief again in 2014,10
as contributions dropped to their lowest level in six years. Since 2008, the TW
Pension 100 has contributed more than $230 billion to their plans.
For 2014, plan sponsors contributed $26.5 billion, down slightly from $27.8
billion in 2013 and down significantly from $44.7 billion in 2012.
Figure 9. Plan contributions from TW Pension 100 ($ billions), 2008 –
2014
Source: Towers Watson
Half of the companies in this analysis contributed less in 2014 than in 2013.
Forty-five sponsors contributed more in 2014 than they did for 2013, and five
contributed the same amounts in both years. It seems as if sponsors that made
large contributions in 2013 cut back in 2014, and sponsors that made smaller
contributions in 2013 upped their contributions in 2014 (Figure
10).
Figure 10. Plan contributions ($ billions), 2013 versus
2014
Source: Towers Watson
Despite the lower contributions in 2014, the median ratio of contributions to
service cost was 1.3, so companies are contributing considerably more than
necessary to keep pace with benefit accruals.
Further de-risking of pension liabilities in 2014
To alleviate some of the risk that comes with managing large pension
obligations, some plan sponsors have offered lump sum buyouts or executed bulk
annuity purchases for certain DB plan participants in the last few years. In
2012 filings, 12 companies explicitly stated having taken such actions, which
reduced aggregate assets and obligations by $42 billion.11
During 2014, some TW Pension 100 sponsors took steps to reduce the size of
their pension obligations. According to explicit disclosures, 23 of these
sponsors made lump sum offers or executed bulk annuity purchases, reducing
aggregate assets and liabilities by roughly $14 billion.
Conclusion
During 2014, falling interest rates coupled with one-time changes to
mortality assumptions pushed plan liabilities significantly higher. While
investment returns were good, cash contributions (while still relatively high)
were the lowest since the financial crisis. So asset gains were not sufficient
to offset dramatically lower funding positions that wiped out a good portion of
2013fs gains.
Lower funding levels are a concern for plan sponsors. Weaker funding
positions will likely necessitate larger cash contributions in the near future,
and higher pension costs will most likely drive up the charge against profits
for 2015, unless equity returns are strong and/or interest rates rise.
De-risking pension plans continues to be important to many sponsors, as
evidenced by another year of lump sum buyouts and annuity purchases. Already in
2015, three companies in the TW Pension 100 have started the process of
transferring some plan obligations to a third-party insurance carrier.
Plan sponsors that adopted an LDI approach to hedge falling interest rates
saw this strategy succeed for 2014. It will be interesting to see how the drop
in pension funding levels and interest rates affects risk mitigation efforts
during 2015.
Endnotes