Mercer: US Pension Deficit Reaches Post-World War II High

(October 5, 2011) — The aggregate deficit of S&P 1500 pension plans increased by $134 billion in September, hitting a “post-World War II high, according to a recent analysis by Mercer.

Mercer showed the aggregate deficit in pension plans sponsored by S&P 1500 companies increased from a deficit of approximately $378 billion as of August 31, 2011, to $512 billion as of September 30.

“The end of September marks the largest deficit since we have been tracking this information,” said Mercer retirement risk and finance partner Jonathan Barry in a statement. “Over the past three months, we have seen nearly $300 billion of funded status erode. This will have significant consequences for plan sponsors. It will be particularly painful for organizations with September 30 fiscal and/or plan year ends.”

According to the consulting firm, the drop in funding ratio was fueled by a 7% drop in equities and a fall in the price of high-quality corporate bonds throughout the month. While discount rates for the typical US pension plan decreased approximately 30-40 basis points during the month, the funding status of S&P 1500 pension plans peaked at 88% at the end of April and has since declined by 16%.

Mercer’s research showed the aggregate funding ratio dropped to 72% from 79% where it stood at the end of August and from 81% since the start of the year.

Kevin Armant, a principal with Mercer’s financial strategy group, added: “The recent market turmoil is a reminder to plan sponsors of the need for a pension risk management strategy that is aligned with corporate objectives…Those that were aware of the risks and can deal with the increased cash funding and P&L charges associated with the current market downturn may choose to stay the course. Those that can’t will continue to evaluate risk reduction opportunities, including increasing interest rate hedging programs, moving more into long corporate bond allocations or transferring risk through the introduction of a lump sum payment option or purchasing annuities.”

As of the end of September, S&P 1500 pension plan assets totaled $1.31 trillion, while liabilities were at $1.83 trillion, Mercer said.

Last month, figures from Mercer showed that August was a dismal month for US pension plan funding levels, which could have potential ramifications for 2012 financials. Nevertheless, Mercer noted that the lackluster news was not unexpected. “For the typical pension plan invested 60% in equities and 40% in aggregate fixed income, the monthly volatility of funded status is between 3% and 4%. The decline in August shouldn’t be seen as an outlier and there is the potential for even more volatility prior to the end of the year,” Armant said.

A recent analysis by Credit Suisse painted a similarly negative picture. The analysis showed a combined $400 billion pension deficit for S&P 500 companies.

The 326 companies within the S&P 500 that have defined benefit pension plans face a total of $388 billion in pension deficits, according to an analysis from the bulge-bracket bank – a number equal to a 77% funding ratio on average. This compares with a $326 billion deficit and 79% funding levels at the end of 2008. This bleak picture is likely the result of low interest rates – which directly influence corporate pension liability calculation under the Pension Protection Act of 2006 – and meager equity markets. “If you think about the typical corporate pension plan, they are continuing to take two big bets: they are betting on interest rates and they are betting on the equity market – and they hope that both go up,” David Zion, head of accounting research for Credit Suisse, told the Financial Times. 

Credit Suisse estimated in its report that each 25 basis-point decline in interest rates increases pension liabilities at S&P 500 companies by upwards of $45 billion. With interest rates at all-time lows – having dropped 50 basis points this year – pensions have been caught in a perfect storm of falling assets and rising liabilities.