Mercer: US Pension Funding Levels Plummet

(September 7, 2011) — Pension plan funding levels in the United States plummeted in August, Mercer has claimed in a report.

The aggregate deficit in pension plans sponsored by S&P 1500 companies increased by $73 billion during August, from a deficit of approximately $305 billion as of July 31, 2011, to $378 billion as of August 31, according to new figures from the consulting firm. This deficit corresponds to an aggregate funded ratio of 79% as of August 31, compared to a funded ratio of 83% at July 31, 2011 and 81% at December 31, 2010.

“August was a wild ride” said Jonathan Barry, a partner with Mercer’s Retirement Risk and Finance Group, in a statement. “We saw funded status plummet on August 8 due to the sharp fall in equity markets and declining Treasury yields, and a lot of ups and downs over the subsequent weeks. A small rally in equities in the last week of August, combined with widening credit spreads on corporate debt, provide some recovery from the early losses, but overall, the outcome was still bad news for pension plans.”

According to the firm, the drop in funded status was fueled by a 5.4% drop in equities and a fall in yields on high quality corporate bonds during the month.

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,” commented Kevin Armant, a principal in Mercer’s Financial Strategy Group.

A recent analysis by Credit Suisse paints 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 estimates 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.