Tag Archives: Pension Funding Study

Spot rate methodology: Plans are making the switch

Moliterno-MariaIn April, Milliman released its 2016 Pension Funding Study. The study looks at the 2015 year end GAAP accounting results for the 100 largest defined benefit corporate pension plan sponsors. A surprising feature of this year’s study is that 37 of the 100 companies in the study disclosed on their Form 10-K financial statements their intentions to value their 2016 net periodic pension cost results using an alternative spot rate method.

Under the standard method typically used for determining pension expense, the yield curve is used to first determine the present value of plan liability. A single equivalent discount rate is determined that produces the same liability. This equivalent discount rate is then used for all purposes in the expense calculation that requires interest adjustments, including calculation of interest and service costs.

The spot rate method is an alternative method to calculate interest and service costs. Calculating the plan’s liability under the spot rate method is similar to the standard method, as the yield curve is used to determine the liability as the present value of payout streams. However, under the spot rate method, costs are developed using the individual spot rates of the yield curve for each year of expected costs. The interest cost for the year is developed by applying each individual spot rate under the yield curve to each corresponding cash flow discounted to the beginning of the year. Because the current shape of the yield curve has low interest rates in the early years and higher rates over time, payouts expected in the next few years are valued at lower rates than in the future. For example, the December 31, 2015, Citigroup Yield Curve has a rate of 1.34% for year 1 and 4.54% for year 20.

With 37 of the 100 pension plan sponsors analyzed planning on adopting the spot rate methodology in 2016 for some or all of their plans, the change is expected to result in savings in the 2016 pension expense for them. According to the 2016 Pension Funding Study, if all 100 companies adopted the spot rate methodology for all of their plans, the 2016 pension expense savings is estimated to be $14 billion (assuming a 20% reduction in the interest cost for a typical company).

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Milliman Hangout: 2016 Pension Funding Study

The 100 largest U.S. corporate pension plans experienced a minuscule funding improvement of 0.1% in 2015, according to the Milliman 2016 Pension Funding Study (PFS). The aggregate funded ratio increased from 81.7% to 81.8% based on a $75.8 billion decrease in the market value of plan assets and a $94.5 billion decrease in the projected benefit obligation (PBO). This resulted in an $18.7 billion improvement in funded status.

In this Milliman Hangout, PFS coauthor Zorast Wadia discusses the results of the study with Amy Resnick, editor of Pensions & Investments.

To read the entire study, click here.

The 100 largest U.S. corporate pension plans’ funded status improved by only 0.1% in 2015

Wadia_ZorastMilliman today released the results of its 2016 Corporate Pension Funding Study, which analyzes the 100 largest U.S. corporate pension plans. In 2015, these pension plans experienced a relatively small funding improvement of 0.1%, as the aggregate funded ratio increased from 81.7% to 81.8% based on a $75.8 billion decrease in the market value of plan assets and a $94.5 billion decrease in the projected benefit obligation (PBO). This resulted in an $18.7 billion increase in funded status. The minuscule improvement belies the fierce dynamics facing these pensions last year.

2014 2015 CHANGE
MARKET VALUE OF ASSETS $1,453.6 $1,377.8 ($75.8)
PROJECTED BENEFIT OBLIGATION $1,779.7 $1,685.2 ($94.5)
FUNDED STATUS ($326.1) ($307.4) ($18.7)
FUNDED PERCENTAGE 81.7% 81.8% 0.1%
NET PENSION INCOME/(COST) ($37.3) ($33.7) $3.6
DISCOUNT RATE 4.00% 4.25% 0.25%
ACTUAL RATE OF RETURN 10.8% 0.9% -9.9%
Note: Numbers may not add up precisely, which is due to rounding.

What a strange year for these 100 pension plans. These pensions weathered volatile markets, unpredictable discount rate movements, adjusted mortality assumptions, pension risk transfers, and an industry-wide decline in cash contributions…and yet they still finished the year almost exactly where they began. Given all that transpired in 2015, plan sponsors may be relieved that plans did not experience funded status erosion like that of the prior year. But that doesn’t change the fact of a pension funded deficit in excess of $300 billion.

Study highlights include:

Surprising move toward spot rates. Thirty-seven of the largest 100 plan sponsor companies will record fiscal year 2016 pension expense using an accounting method change linked to the spot interest rates derived from yield curves of high quality corporate bonds. The move to spot rates will result in pension expense savings.

Actual returns well below expectations. Actual plan returns were 0.9% for the year—just a fraction of the expected 7.2%.

Impact of updated mortality assumptions. Pension obligations at the end of 2015 were further reduced to reflect refinements in mortality assumptions. While we are unable to collect specific detail regarding the reduction in PBO, a 1% to 2% decrease has been anecdotally reported. Additional revisions to mortality assumptions may be published in the fourth quarter of 2016.

Cash contributions reduced by almost $9 billion. Approximately $40 billion was contributed in 2014, with that number falling to $31 billion in 2015. The likely cause of the decline: the continuation of interest rate stabilization (funding relief) courtesy of the Bipartisan Budget Act of 2015.

Pension Risk Transfers continue. The estimated amount of pension risk transfers collected from the accounting disclosures was nominally higher in 2015 ($11.6 billion) compared with 2014 ($11.4 billion). It seems likely these transactions may increase in 2016, spurred by the significant increases during 2015 in premiums payable to the Pension Benefit Guaranty Corporation (PBGC); the extension of these premium rate increases was also courtesy of the Bipartisan Budget Act of 2015.

Equity allocations reach a record low. By the end of 2015, equity allocations had dropped to 36.8%, the lowest in the 16-year history of this study. In recent years, the companies in the study generally shifted toward fixed income investments. However, unlike 2014—when plans with higher allocations to fixed income outperformed plans with lower allocations—2015 saw plans with higher allocations to fixed income experience the same rate of return as those with lower allocations.

Under the radar. The 2016 Pension Funding Study also reports on the funded status of Other Postemployment Benefits (OPEB) Plans.

To download the study, click here.

Milliman infographic: Pension liabilities

When the discount rate increases the projected benefit obligation (PBO), or pension liability, decreases, and vice versa. This relationship explains the volatile nature of pension liabilities and demonstrates why liabilities-driven investment strategies, which manage funded status and limit volatility of pension liabilities and asset returns, are useful.


To read the entire Corporate Pension Funding Study, click here.

Milliman Hangout: 2015 Pension Funding Study

The funded status of the largest 100 corporate defined benefit plans declined by $131.3 billion in 2014 as measured by the 2015 Milliman 100 Pension Funding Study (PFS). Plan liability increases overwhelmed robust asset investment gains and annual contributions declined to $39.8 billion from $44.2 billion in 2013. PFS coauthors John Ehrhardt and Zorast Wadia discuss the results of the study with Amy Resnick, executive editor of Pensions & Investments, in this Milliman Hangout.

To read Pensions & Investments’ coverage of the study, click here.
To download the 2015 Milliman 100 Pension Funding Study, click here.

Discount rates deepen pension funding deficit and make 2014 a banner year for liability-driven investing

Ehrhardt-JohnMilliman today released the results of its 2015 Pension Funding Study, which analyzes the 100 largest U.S. corporate pension plans. In 2014, these pension plans experienced a funded status decline despite a 10.9% investment return, with plan liabilities for these 100 plans increasing by $189.2 billion and assets increasing by $57.9 billion. This resulted in a $131.3 billion increase in the funded status deficit, representing a funding ratio decline of 6.1%.

Pension plan sponsors may be feeling whiplash after the last three years. In 2012, plans with the heaviest investment in fixed income experienced superior returns. In 2013, we saw the opposite: Plans with heavy equity allocations fared the best. Now with these latest results, we’ve again reversed ourselves, as plans with the highest fixed income allocation once again outpaced the field despite a strong year for equities. This whiplash is the result of discount rates that hit a record low this year, and continue to define pension funding status.

Study highlights include:

Asset allocations shift toward fixed income. Equity allocations in the pension portfolios dropped to 37.3% by the end of 2014, the lowest in the 15-year history of this study. The companies included in this study have generally shifted toward higher allocations in fixed income investments.

Risk transfer trend continues. Some plan sponsors engaged in pension risk transfer activities, including two well-publicized pension buyouts conducted for two of the Milliman 100 companies (Bristol-Myers Squibb and Motorola).

New mortality assumptions increase pension liabilities by 3.4%. The magnitude of these increases is contingent on age, gender, and other demographic characteristics of each plan’s participants. Based on the footnote disclosures at year-end 2014, the new Society of Actuaries mortality tables led companies to update mortality assumptions, increasing pension liabilities by approximately $38.3 billion, or 3.4%, at least among those plans that disclosed the impact.

Contributions decline during 2014. The $39.8 billion in contributions during 2014 were the lowest level since 2008 and marked a $4.4 billion decrease from 2013 contribution levels. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategies in light of the Highway and Transportation Funding Act of 2014 (HATFA) interest rate stabilization legislation, enacted in August 2014.

Pension expense increases. Robust investment gains in 2013 were partially offset by the impact of lower contributions and increasing discount rates during 2013, producing a net increase of $4.8 billion and resulting in a total of $37.1 billion in pension expense. Pension expense hit an all-time high at $56.1 billion in 2012.

What to expect in 2015. The passage of HATFA may result in lower contributions on par with those seen in 2014. However, for plans already engaged in liability-driven investing (LDI), higher contribution levels can be expected. The lower discount rates at the end of 2014 are expected to lead to significant 2015 pension expense increases because discount rates for the coming fiscal year are set at the start of the fiscal year. This does not factor in any possible plan de-risking activity.

Pension plans: How’s that de-risking going?

Herman-TimCorporate pension plans had a good year in 2013. The Milliman 2014 Pension Funding Study reported a $198.3 billion improvement in the funded status deficit during 2013. This improvement was due to a win-win situation where there was a 7.5% decrease in plan liabilities from higher discount rates and a 9.9% average return on plan assets.

There are a few interesting pieces of information that can be gleaned from the Pension Funding Study about plan sponsors that have made moves to de-risk their pension plans.

• In general, the asset allocations of the plans in the study have shifted toward a higher allocation of fixed income investments. However, some plan sponsors have retained a more traditional asset mix.

• In 2013, plan sponsors with higher allocations to equities experienced greater improvement in pension funded status than those with lower exposures to equities.

• Some plan sponsors who undertook de-risking activities such as lump sum payouts or annuity purchases may need to increase cash contributions to maintain funded status.

  • For example, Ford was one of the companies that undertook de-risking activities in 2012. Its 2013 contribution increased by more than $1.6 billion.

• There are 22 pension plans in the Milliman 100 index that had asset allocations to fixed income investments over 40% in 2009. Since 2009:

  • These 22 plans experienced significantly lower funded ratio volatility than the other 78 plans.
  • From 2010 through 2012, these plans earned higher average annualized returns.
  • Until 2013, this strategy paid off for these plans in terms of reducing funded status volatility.

• For the plans that did not increase asset allocations to fixed income investments, the combination of higher interest rates to discount liabilities with favorable returns on assets led to a significant improvement in their funded ratios.

What are the morals of the story? De-risking pension plans may provide advantages to plan sponsors in reductions in funded status volatility. But these advantages may come at the price of higher cash contributions and missing out on favorable moves in the market.

Possible MAP-21 extension presents additional funding stabilization

A provision appended to the Emergency Unemployment Compensation Extension Act of 2014 may offer defined benefit (DB) plan sponsors continued funding relief. The provision would extend the funding stabilization authorized under the Moving Ahead for Progress in the 21st Century Act (MAP-21) another five years.

In a recent Bloomberg BNA article, Zorast Wadia talks about the benefits of lengthening the MAP-21 provision. Here is an excerpt:

The MAP-21 provisions stabilize the discount rates used to calculate employers’ pension funding obligations by adjusting rates if they fall outside of an interest rate “corridor” tied to average rates over a 25-year period. Those corridors gradually widen through 2016, weakening their impact. The provisions were designed to raise revenue by lowering companies’ required pension contributions and thereby driving up taxable income and projected tax receipts.

As the MAP-21 smoothing provisions enter the midway point in 2014, plan sponsors are beginning to see the relief wear off, said Zorast Wadia, a principal and consulting actuary in the New York office of Milliman.

Interest rates continually declined from 2009 to 2012, and only began to rebound in 2013, so pension liabilities still remain at all-time highs, Wadia said. Lessening the relief could put many sponsors in a “tough situation again,” he said.

Under MAP-21, the corridor incrementally widens from 10 percent in 2012 to 30 percent in 2016. Under the unemployment insurance legislation, the corridor would remain at 10 percent through 2017 and incrementally widen to 30 percent after 2020.

There is a lot of incentive to fully fund plans more quickly, one reason being rising premiums set by the Pension Benefit Guaranty Corporation, Wadia said. “But those [plans] that are cash-strapped will probably welcome this opportunity, and continue to eke by, to do what they need to get on through,” he said.

Results from the 2014 Pension Funding Study (PFS) suggest that plan sponsors took advantage of MAP-21’s funding relief. Contributions declined significantly during 2013, according to the PFS.

The $44.1 billion in contributions during 2013 (down $18.1 billion from $62.2 billion in 2012) was the lowest level in five years. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategy in light of the MAP-21 interest rate stabilization legislation, passed in July of 2012. Seven companies decreased their contribution by more than $1 billion in 2013 compared with 2012, for a total of $13.3 billion….

In 2013, corporate pension plans with the highest equity exposure were the biggest benefactors

Milliman today released the results of its 2014 Pension Funding Study (PFS), which analyzes the 100 largest U.S. corporate pension plans. In 2013, these pension plans experienced historic improvement, with plan liabilities decreasing by 7.5% and assets improving by an average of 9.9%. This resulted in a $198.3 billion improvement in the funded status deficit from year-end 2012. While it was a “win-win” year for most sponsors, those with higher equity allocations performed the best.

Last year was a great year for pension funded status and helped reduce much of the underfunding that has persisted since the global financial crisis. Plans that held off on de-risking their plans were the biggest benefactors of the strong equity performance. With 18 of the 100 plans in our study now fully funded, and more hopefully reaching full funding this year, the timing for de-risking activities that can lock in funded status may be optimal.

Study highlights include:

Interest rate increases evident in financial statements. The discount rates used to measure plan obligations increased from 4.04% to 4.75% in 2013. While these rates are still down from a high water mark of 7.63% in 1999, the improvement in 2013 went a long ways toward minimizing the pension funded status deficit.

Investment performance exceeded expectations. The weighted average actual investment return on pension assets for the Milliman 100 companies’ 2013 fiscal years was 9.9%, which compares favorably to the expected return of 7.4%.

Contributions decline significantly during 2013. The $44.1 billion in contributions during 2013 (down $18.1 billion from $62.2 billion in 2012) was the lowest level in five years. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategies in light of the Moving Ahead for Progress in the 21st Century Act (MAP-21) interest rate stabilization legislation, passed in July 2012.

Pension expense decreased. Favorable investment returns in 2012 offset the impact of declining discount rates in that year, leading to a reduced level of pension expense: a $32.1 billion charge to earnings. This is $23.7 billion lower than the record high pension expense in 2012.

Market capitalization of these plans up more than 20%. The favorable equity market performance during 2013 increased the total market capitalization for the Milliman 100 companies by 21.2%. When combined with the decrease in pension obligations, this resulted in a decrease in the unfunded pension liability as a percentage of market capitalization, from 7.3% at the end of 2012 to 3.0% at the end of 2013.

Asset allocations remain relatively stable. The trend toward implementing liability-driven investing (LDI) continued in 2013, but at a slower pace. Overall allocations to equities remained largely unchanged in 2013. With strong 2013 returns across most equity markets and losses in many fixed-income sectors, it is evident that many plans rebalanced during the year by moving money from equities, and possibly other asset classes, to fixed income.

What to expect in 2014. Given the funded status gains in 2013, 2014 contributions are expected to decrease compared to those made in 2013. Plans already at surplus at the end of 2013 will have reduced incentive to further fund their plans in 2014. For some plans that had already engaged in LDI or other funded status lock-in strategies, higher contribution levels can be expected.

Given the compound effect of favorable investment returns in 2013 and higher discount rates at year-end, we estimate that 2014 pension expense will decrease to $19 billion, a $13 billion decrease compared with 2013. We may see more than 30 of the Milliman 100 companies with pension income in 2014, a level not seen since 2002.

To read the entire study, click here.

Watch Milliman’s Google+ Hangout where Zorast Wadia and I discuss the results of this year’s PFS with Pensions & Investments Executive Editor Amy Resnick.

Declining interest rates produce record pension deficit in 2012

Milliman today released the results of its 2013 Pension Funding Study, which analyzes the 100 largest U.S. corporate pension plans. In 2012, these pension plans were once again defined by record-low discount rates, which led to record-high pension obligations and a $388.8 billion pension funding deficit—a $61.1 billion deficit increase in 2012. Since the end of 2010, declining interest rates have widened the pension funding deficit by more than $150 billion, driving record deficits in each of the last two years. The pension funding ratio stood at 77.2% at year’s end, down from 79.2% at the end of 2011. The deficit increase and reduced funding ratio in 2012 happened in spite of efforts by certain plan sponsors to de-risk their pension plans.

Many plan sponsors made significant efforts to de-risk their pension plans in 2012, even as record-low interest rates made it an expensive time to pursue these kinds of risk management efforts. But there was no fighting the inevitable gravity of these low interest rates, as the 100 pension plans in our study saw a cumulative deficit increase in excess of $60 billion. All this in spite of strong asset performance that exceeded the expectations of most plan sponsors. People are probably getting tired of hearing me say this, but pension funding status will continue to be tied to interest rates. If rates stay low—and all indications are that they will through 2014—these pension plans will struggle to fill their funding gaps.

Major pension stories for 2012 include:

De-risking results in shake up at the top of the Milliman 100. Throughout the 13 years Milliman has performed this analysis, General Motors (GM) has been the largest pension plan, based on total assets. That changed in 2012 after GM pursued de-risking efforts. IBM—long a solid #2 in the study—is now the largest pension plan in the Milliman 100. Other large plan sponsors, including Ford and Verizon, also pursued de-risking. Across the entire Milliman 100, de-risking by at least 15 plan sponsors resulted in a cumulative $45 billion reduction in plan obligations.

Asset increases and $61.5 billion in contributions were not enough to close the deficit. With an 11.7% investment return in 2012, the Milliman 100 pension plans performed better than they expected—but it wasn’t enough to offset the ballooning deficit. Nor were contributions in excess of $60 billion.

Record contributions in 2012—but not at the level expected. While the $61.5 billion in contributions during 2012 was significantly greater than most prior years, it exceeded the 2011 total by only $6.3 billion and the 2010 total by only $1.8 billion. The lower-than-expected contributions were likely due to plan sponsors electing to change their contribution strategies following the passage of the Moving Ahead for Progress in the 21st Century Act (MAP-21) interest rate stabilization legislation.

Another record year for pension expense. Following a $38.5 billion charge to earnings in 2011, the Milliman 100 pension plans again set a new record for total pension expense, with a $55.8 billion charge to earnings. The $17.3 billion increase in pension expense is consistent with the prediction of $16 billion reported by last year’s study. This year’s study predicts a $7.6 billion increase in pension expense in 2013.

Asset allocations relatively stable. In 2011, plan sponsors decreased the percentage of assets invested in equities by more than 5%. In 2012, the percentage of assets allocated to equities remained relatively stable (from 38.2% to 38.0%), as the move toward liability-driven investments (LDI) slowed. Because of the strong performance of equities in 2012, plans with higher equity allocations had better investment returns than those with higher allocations to fixed-income investments.

What to expect in 2013. With the Federal Reserve Board indicating its intention to keep interest rates low through 2014, pension obligations will remain high. The year is off to a strong start from an equity perspective, and de-risking may continue in 2013. But until interest rates move favorably, the pension funding deficit is likely to endure.