Press Releases

Fewer Companies Have Sufficient Funds to Cover Pension Liabilities

WASHINGTON, November 25, 2002 — The stock market’s steady decline is expected to force U.S. companies to contribute billions of dollars into their pension plans in the next several years to address funding shortfalls and comply with federal laws that protect workers’ pensions.

Only about 15 percent of employers made pension plan contributions in 2000, and that number increased to about 25 percent in 2001, according to research by Watson Wyatt. For the current year, Watson Wyatt estimates that about 30 percent of the plans will require contributions and, if current market conditions persist, that number could more than double to 65 percent in 2003.

Meanwhile, as asset values have declined, liabilities have soared and fewer companies have sufficient funds to fully cover their pension liabilities. In fact, Watson Wyatt research shows that only about 40 percent of pension plans had assets in excess of plan liabilities as of January 1, 2002, down from about 85 percent in 2000. If current economic conditions persist, it is likely that only about one-fifth of plans will have sufficient funds to fully cover liabilities in 2003.

“Pension funding laws were originally developed to allow employers to budget pension contributions over time with flexibility, so they could fund more in good times and less in bad times,” says Kevin Wagner, a retirement practice director with Watson Wyatt. “But with numerous changes to funding rules over the past 15 years, today’s laws have precisely the opposite effect.”

Current law requires an annual comparison of a plan’s current liability with its valuation assets. Simply stated, if the ratio falls below 0.9 the plan may be subject to additional minimum funding requirements above and beyond “normal” funding requirements, but if the ratio exceeds 1.0, plan contributions may not be deductible. Because of this relatively narrow range, contributions can be very volatile from year to year. With the recent market declines, many plans went from a situation where contributions were not deductible to a situation where significant contributions had to be made.

“The bottom line is that if employers aren’t given more flexibility in terms of when they can or can’t make pension plan contributions, they won’t sponsor these plans,” notes Wagner. “Without orderly funding, employers have difficulty managing other important costs, including pay budgets and technology investments. And ultimately, this hurts employees the most.”

Wagner also notes that the volatility associated with pension funding encourages plan sponsors to invest more heavily in fixed-income securities than they otherwise might. “A 100-percent fixed income asset allocation is likely to provide lower investment returns, but it allows employers to control the volatility of pension contributions and more accurately budget over time. Unfortunately, employees pay the price for these foregone investment returns in the form of lower benefits in the long run.”

To smooth the pension funding process, Watson Wyatt proposes that an employer’s current liability be determined based on interest rates in effect as of the date of the plan’s valuation rather than on the current liability based on a four-year weighted average of 30-year Treasuries. “This measurement represents a much more accurate measure of the plans’ funded status at the valuation date,” said Wagner.

Watson Wyatt also proposes that instead of providing employers with flexibility in determining current liability interest rates (90 to 120 percent of the four-year weighted average of 30-year Treasury bonds), that the current 90 to 120 percent range apply directly to determining funding contributions. If a plan’s funded status falls below 90 percent, rules similar to those currently in place to accelerate funding requirements would continue. However, to encourage adequate plan funding, contributions could be allowed to fund a plan up to 120 or 130 percent of a plan’s current liability.

“Despite these difficult economic and funding challenges, retirement benefits payable under most defined benefit plans are secure and are in much better shape than the defined contribution plan system, where employees are bearing the market risk,” said Wagner. “What we need now are changes in the funding process that will ensure employers will want to keep offering a defined benefit plan to their workers.”

Watson Wyatt & Company

Watson Wyatt & Company, the primary subsidiary of Watson Wyatt & Company Holdings (NYSE: WW), is an international human capital consulting firm that provides services in the areas of employee benefits, human resources technologies and human capital strategies. The firm is headquartered in Washington, D.C., and has more than 4,200 associates in 61 offices in the Americas and Asia-Pacific. Together with Watson Wyatt LLP, a leading European-based consulting partnership, the firm operates globally as Watson Wyatt Worldwide. Watson Wyatt Worldwide has more than 6,300 associates in 88 offices in 30 countries.

Media Contacts

Meredith Mazza, 202-715-7578, meredith.mazza@watsonwyatt.com
Ed Emerman, 609-452-5967, eemerman@eaglepr.com