Recent Funding and Sponsorship Trends Among the FORTUNE 1000

The last five years have been difficult ones for firms that sponsor defined benefit pension plans. Volatility in financial markets arrived at a time when many firms were facing poor business conditions. Legal and regulatory uncertainties have compounded the challenges. This article documents the evolving financial status and sponsorship trends among FORTUNE 1000 firms that sponsor defined benefit pensions through the end of 2004. The finances of defined benefit plans continue to improve, owing in part to large contributions from employers. The rate of defined benefit plan sponsorship has remained steady among large employers, although a handful of firms have frozen benefit accruals or closed their plans to new hires.

The Finances of Defined Benefit Plans

The funding ratio for pension funds sponsored by FORTUNE 1000 firms showed slow but steady improvement over the last two years (Table 1). The funding ratio is the market value of plan assets divided by the present value of projected benefit obligations. The average measure takes the mean funding ratio across firms, while the aggregate figure sums up all assets and divides by liabilities. The fact that the aggregate is greater than the average indicates that larger plans tend to be better funded. After years of being fully and overly funded in the late 1990s, average funding levels fell to a trough of 76 percent in 2002, owing to three years of poor investment results that decimated asset values and declining discount rates that pushed up present value measures of liabilities. Owing to improved returns in equity markets and sizable cash contributions by plan sponsors, the average funding ratio stepped up to 81 percent in 2003 and 83 percent in 2004, while the aggregate moved up to 89 percent in 2003 and 90 percent in 2004.

Table 1
Funding Ratio for FORTUNE 1000 Firms*

*To control for the timing of changes in financial markets, we analyzed firms whose fiscal year ending date fell between October and December.
Source: Watson Wyatt Worldwide.

The breakdown of the components that led to the increase in funding status for 2003 and 2004 is shown in billions of dollars in Table 2. The FORTUNE 1000 firms that sponsored a defined benefit plan in 2003 realized a robust average return on their plan assets of 20.7 percent in 2003 and 12.2 percent in 2004. Employers also shored up their funds by contributing cash well in excess of their service cost, which is the value of benefits earned in that year alone. Such sizable commitments must have seemed like swimming against the tide as discount rates declined from an average of 6.7 percent in 2002 to 6.2 percent in 2003 and 5.9 percent in 2004, creating large actuarial losses in both years.

Table 2
Changes in Pension Funding for FORTUNE 1000 Firms during 2003–2004 ($ billions)

* Other consists of curtailments, settlements, acquisitions, divestures and plan amendments.
Source: Watson Wyatt Worldwide.

Aggregate funding statistics mask the fact that funding status varies widely across industries, which is shown in Figure 1 for 2004. The banking, securities and commodity broker industry had the highest funding status — an average funding ratio of 99 percent. The communication and utilities industries were also quite well funded at 91 percent and 86 percent, respectively. At the other end of the spectrum, the other transportation group recorded the lowest funding status with an average funding ratio slightly under 70 percent. This largely reflects the financial stress and, in some cases, bankruptcy of airline companies over the past couple of years. Most of the remaining sectors averaged around 80 percent funding.

Figure 1
Average Funding Ratio by Industry 2004

While plan sponsors have made progress in improving the financial position of their pension funds, on average firms are still well below full funding. This is partly due to the high degree of equity exposure in most plans and the relatively poor returns over the past five years as a whole. Since equity returns often move with the interest rate assets that drive liability valuations, such high stock allocations have resulted in volatile funding positions. The subject of asset allocation in defined benefit pension plans will be discussed in more detail in next month’s Insider.

Trends in Sponsorship

Lackluster financial market conditions in recent years combined with legal uncertainties about the status of cash balance plans and proposals to impose stricter funding requirements have prompted many plan sponsors to reevaluate their commitment to their defined benefit plans. While anecdotes abound, it is more difficult to get a concrete sense of the actual magnitude of the trend away from defined benefit plan sponsorship.

Watson Wyatt has been collecting data for the last four years on whether plans sponsored by FORTUNE 1000 firms have been frozen or are in the process of being terminated, meaning there are no new benefit accruals for any plan participant.1 For 2004, we also collected information on whether plans have active benefit accruals for some or all participants but are closed to new hires.

The rate of defined benefit plan sponsorship has remained fairly constant over the past four years at just over 60 percent (Table 3). This is true despite the turnover rate of roughly 7 percent of firms on the FORTUNE 1000 list, suggesting that defined benefit plan sponsorship is the same for firms joining the FORTUNE 1000 as for those dropping off the list. The third column in Table 3 shows that the number of plans that were either frozen or terminated rose from 7 percent of all defined benefit plan sponsors in 2003 to 11 percent in 2004.

If we subtract firms whose plans are closed, frozen or terminated, defined benefit plan sponsorship among FORTUNE 1000 firms stands at 53 percent. Generally, the larger a plan is relative to the firm’s market value, the more likely the plan remains fully active.

Table 3
Prevalence of DB Sponsorship and Plan Freezing or Termination among FORTUNE 1000 Firms

Freezing or terminating a plan appears to occur more often in less profitable firms. For 2001 through 2004, about half of the companies that terminated their plan in any given year dropped off the FORTUNE 1000 list in the following year. In 2004, of the 71 companies that had frozen or terminated plans, just under half had below investment-grade credit ratings, as compared with 25 percent of firms with active defined benefit plans. In addition, these firms had an average funding ratio of 75 percent, as compared with 83 percent for the active sample. There is no strong pattern across industries, although the finance and retail industries are somewhat more likely to freeze or terminate their plans than plans overall (roughly 15 percent versus 11 percent).

Our data suggest that 25 firms had active benefit accruals but were closed to new participants in 2004. In contrast to freezing or termination, closing off participation to new participants (presumably implying a defined-contribution-only approach going forward) does not appear to be confined to troubled companies; funding ratios and credit ratings were comparable to those in fully active plans.

It also appears that the number of companies sponsoring cash balance or other hybrid pension plans has not increased in recent years and actually edged down last year, which is not surprising in light of the litigious environment surrounding these plans. It is worth noting that in reevaluating the role of defined benefit pensions, many companies have recommitted to these plans, albeit perhaps with changes in plan design. We hope to document these trends in future issues of the Insider.