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CCH® PENSION AND BENEFITS — 07/02/09

Mercer study shows marked decline in financial health of DB plans

In 2008, the financial health of defined benefit pension plans at the largest U.S. companies worsened markedly, with aggregate pension assets falling $310 billion short of pension liabilities, according to Mercer's annual analysis of the retirement programs of the S&P 500 companies. Mercer based its analysis primarily on information contained in the 10-K reports filed by the companies in the S&P 500 for the 2008 fiscal year.

The Mercer study also found that, in 2008, for the first time, employers' median spending on defined contribution (DC) benefits exceeded their median spending on earned pension benefits. "Retirement programs - including traditional defined benefit (DB) pension plans - are an important, and integral, part of a company's financials as well as a key human resource strategy, but they operate in a changing landscape," said Steve Alpert, a principal and consulting actuary with Mercer and primary author of the study. "For the first time we are seeing that companies are spending more on their 401(k) and other DC plans than they are on providing their employees with pension benefits for the current year of service, reflecting years of DB plan freezes, closures or other cutbacks."

Mercer's study details the shifting benefits landscape, with the median DC plan costing 0.39% of revenue in 2008, as compared to the median value of DB benefit accruals of 0.38% of revenue. Although DC spending was relatively constant from 2005 through 2008, DB spending was down from 0.51% of revenue in 2005, the study found. "In the new landscape, employees will have to shoulder both a greater share of the burden for their own retirement and more of the associated risks," Alpert said. "As employees begin to understand this new dynamic, employers that recognize and address these emerging employee needs may have a competitive advantage in the labor market."

Plan portfolios still at risk

Plan sponsors continue to take investment and interest rate risks with their pension portfolios, according to the Mercer study. Although many have taken some steps - such as increasing the percentage of plan assets devoted to fixed income securities - to at least partially mitigate the interest rate risk, 2008's performance shows that balance sheets are still exposed to a significant amount of risk.

The average target asset allocation for pension assets is 58% equities, a five-percentage-point decrease during the past four years. Sponsors that invested less than half of their plan assets in equities had actual asset returns during 2008 that, although still negative, were approximately 10% to 20% better than the returns generated by the sponsors with more than half of the plans' assets invested in equities.

According to the study, 2008 revealed a previously little-considered risk of changing credit spreads - the difference between the discount rates used to value pension obligations and the yields on Treasury bonds that are included in the fixed income portion of many pension portfolios. In 2008, the increase in credit spreads was unprecedented, meaning that Treasury bond assets increased in value relative to pension liabilities. As noted in the Mercer study, if credit spreads return to their historical norms, an investment in Treasuries will likely significantly underperform both liabilities and corporate bonds.

Outlook for 2009

"As we move forward in 2009, the capital markets and the economic environment remain volatile," said Alan Parikh, a principal in Mercer's Financial Strategy Group and another of the study's authors. Projected year-end pension funded status is impossible to predict at this point, Parikh said.

Parikh added that market conditions have "severely stressed" many plan sponsors, and though they received some temporary relief from the most painful funding implications, those sponsors will need a roadmap for funding and managing the deficits in 2010 and beyond.

Source: Mercer press release, June 15, 2009.

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