The recent downturn in global stock markets has left the largest pension plans in the US up to $110 billion worse off compared to their position as of December 31, 2007, according to actuaries at Mercer. Mercer estimates that many of these pension plans will have seen their funded status decrease by 7%-8% during the first three weeks of 2008.
Changes in the value of equities and changes in the yields on high-quality corporate bonds affect the value of company pension plan assets and liabilities. Under new accounting standards, these changes appear directly on the sponsor's balance sheet.
"We saw a general improvement in the funded status of pension plans in 2007. While asset returns generally met expectations in the 7% to 9% range, discount rates used to value pension plan liabilities rose between 25 and 50 basis points, which, for a typical US pension plan, resulted in a decrease in liabilities of 2% to 8%," said Jonathan Barry,
a member of Mercer's Financial Strategy Group. This group of actuaries and investment professionals help plan sponsors understand and manage the risks inherent in their pension programs.
"For many if not most plan sponsors, any improvement due to market conditions in 2007 has been more than wiped out in the past few weeks, as equity markets have declined significantly," said Mr. Barry. "We are waiting to see how the Fed's decision to lower rates will ultimately impact corporate bond yields. We may also see some downgrades in credit ratings that would tend to lower yields on high quality corporate bonds. Certainly, all indications are pointing to lower corporate bond yields - and higher pension liabilities - in the near-term."
As company pension funds invest for the long term, the current market volatility should be of limited concern to well-managed plans that accept measured amounts of exposure to equity volatility as part of a robust financial strategy, according to Mercer.
"The events of the past few weeks highlight the need for companies to plan for a possible market downturn and either take steps to de-risk their defined benefit plans or conclude they can tolerate the risks," said Adrian Hartshorn, also a member of Mercer's Financial Strategy Group. "While we have seen many companies take steps to manage interest rate risk, the fundamental mismatch between the behavior of equities and the plan liabilities remains largely unaddressed. Longer-term, if equity
markets stabilize at a lower level and the Fed's interest rate changes lower the yield on corporate bonds, more funding will be needed over time. Additionally, corporate earnings will be lower as the impact feeds through into the pension plan accounting requirements."
Mr. Hartshorn added, "The interaction between the financial health of the pension plan and the financial position of the company has never been greater. Increasingly we are aware of equity analysts adjusting their earnings forecasts to reflect the underlying risk of pension plans."
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Commenting on the wider impact of market volatility on individual participants of defined benefit plans, Mr. Hartshorn said: "Most participants in defined benefit plans should not be overly concerned. A fall in the value of their plan's assets is probably less significant than the impact of any recession on their employer, who will need to fund the benefits in the long-term. Whilst there has been much discussion about a potential recession, no one is predicting widespread bankruptcy."
Mr. Hartshorn added, "There are a minority of defined benefit plans with weak sponsors and aggressive 'stay-in-the-casino' investment strategies. There is now a greater chance that these plans will fail through corporate bankruptcy and, while their members are partially protected by the Pension Benefit Guaranty Corporation (PBGC), the potential for increased PBGC premiums for everyone else is greater if equity markets and interest rates stay down."
