Watson Wyatt Pension 100 — 2008 Disclosures of Funding, Discount Rates, Asset Allocations and Contributions

During the latter months of 2008, Watson Wyatt projected year-end pension funding status for accounting purposes at various times, capturing different interest rate and market environments.¹ Now Watson Wyatt has analyzed actual funded status for the 100 largest pension sponsors among publicly traded companies with year-end 2008 fiscal dates, as disclosed in their Securities and Exchange Commission (SEC) 10-K filings.² During 2008, actual funding ratios in this group declined by an average of 28 percentage points.

This article examines actual funding results at year-end 2008, the discount rate assumptions plan sponsors used to measure their liabilities, asset allocations, cash contributions to pensions in 2008 and expected contributions for 2009.

Actual year-end funding status
For all 100 companies in aggregate, the funding ratio — the sum of assets over the sum of projected benefit obligations (PBO) — fell from 109 percent at year-end 2007 to 79 percent by year-end 2008. Plan assets declined by 26 percent, from $1.08 trillion to roughly $799 billion (see Figure 1). At the same time, plan liabilities grew by slightly more than 2 percent, from $992 billion to roughly $1.02 trillion. Among these companies, an $85.9 billion surplus at year-end 2007 had become a $217.5 billion deficit by year-end 2008 — a net loss of roughly $303 billion over the year.

Figure 1
Aggregate funding status for top 100 pensions (n=100; $ billions)

Source: Watson Wyatt Worldwide.

The average funding ratio for the group at year-end 2008 was 75 percent, compared with 103 percent at year-end 2007. This decline significantly shifted the distributions of funding ratios over the last year (see Figure 2).

Figure 2
Distribution of funding ratios for top 100 pensions (12/31/2007- 12/31/2008) (n=100)

Source: Watson Wyatt Worldwide.

At the end of 2007, the vast majority (80 percent) of plans were more than 90 percent funded. Only 7 percent of plans had funding levels between 60 percent and 80 percent. In contrast, by year-end 2008, only a minority —14 percent — of plans had funding levels of 90 percent or more. In most (61 percent) of these plans, funding levels were between 60 percent and 80 percent.

Discount rate assumptions
Toward the end of 2008, there was considerable concern about discount rates because of the volatility in corporate bond yields. The average discount rate used by the top 100 plan sponsors for year-end accounting purposes was 6.36 percent for 2008, up 10 basis points from 6.26 percent, the average rate at year-end 2007. Fifty-five percent of plan sponsors used a higher rate in 2008 than in 2007. Nineteen percent of companies used the same discount rate assumption at year-end 2007 and year-end 2008 (see Figure 3), and 26 percent used a lower rate in 2008.

Figure 3
2007/2008 Discount rate assumptions for top 100 pensions (n=100)

Source: Watson Wyatt Worldwide.

Asset allocations
Among the largest 100 pensions, plan assets declined by 26 percent over 2008, mostly due to the unprecedented losses in equities (most plans remained heavily invested in equities). Figure 4 depicts the average asset allocation for this group of companies at the end of 2007 and 2008.

Figure 4
Average asset allocation percentages for top 100 pensions (12/31/2007-12/31/2008) (n=100)

Source: Watson Wyatt Worldwide.

At the end of 2007, on average, 59 percent of pension plan assets were invested in equities while 30 percent were invested in debt instruments. At the end of 2008, on average, only 48 percent of plan assets were invested in equities while 37 percent were invested in debt. This change is mostly attributable to drastic and sudden losses in the stock market rather than to a shift in investment strategy (as discussed later). Many plans lost value in equity holdings while gaining value in debt instrument holdings, which automatically redistributed their asset allocation by year-end.

Figure 5 shows the percentage of assets invested in equities at the beginning of 2008 and the rates of return for the year. At the beginning of 2008, 67 percent of plans allocated between 55 percent and 74.9 percent of their assets to equities. The relationship between percentage of assets devoted to equities and investment losses is nearly linear.

Figure 5
Equity allocations and rates of return for top 100 pensions in 2008 (n=100)

Source: Watson Wyatt Worldwide.

Plan sponsors’ target asset allocation strategies have changed — albeit minimally — in the financial crisis. We analyzed the 83 companies that provided target allocation data for both 2008 and 2009, as shown in Figure 6. Average allocation targets for 2008 were 58 percent to equities, 31 percent to debt, 4 percent to real estate and 6 percent to alternative investments. Some of these companies changed their strategies for 2009 by reducing the target allocation to equities and increasing target holdings in debt and alternative investments, probably to hedge risk in 2009. This shift was minor —average target asset allocations to equities were 55 percent for 2009 versus 58 percent for 2008.

Figure 6
Average target asset allocation percentages for top 100 pensions (2008 and 2009 policies) ( n=83)

Source: Watson Wyatt Worldwide.

Employer cash contributions
During these tough economic times, most plan sponsors are particularly concerned about the amount of cash they must contribute to their pension funds. For calendar year 2007, 97³ of the firms in this analysis contributed $17.7 billion to their plans (as shown in Figure 7). Sponsors contributed $18.4 billion in 2008. Over 2009, these same companies expect to contribute $27.7 billion — a 50 percent increase over 2008 contributions. While many firms’ required contributions (based on the recent funding shortfall) are not due until 2010, some of these companies want to contribute more in 2009, essentially to smooth the sizable cash contributions ahead owing to the recent pension shortfall.

Figure 7
Actual and expected plan contributions for top 100 pensions (n=97)

Source: Watson Wyatt Worldwide.

Conclusion
Driven by negative market returns, aggregate and average pension funding levels declined significantly during 2008. The financial market turmoil highlights the short-term risk to pension funding of substantial allocations in equities. Many plan sponsors remain committed to equity investments, which have generally been expected to provide the best long-term results. However, large equity positions make plan funding more vulnerable to risk, as assets rise and fall with the stock market. Due to this volatility, many plan sponsors will have to make larger contributions over at least the next couple years.

Employers can minimize pension risk with liability-driven asset allocation strategies. These strategies utilize bond and derivative markets to help companies better hedge their long-term pension liabilities and reduce the pension risk posed by large equity concentrations. A long-term solution to market-driven pension shortfalls and associated volatility would be to eliminate disincentives to build up significant surpluses, such as by reducing the excise tax on excess pension assets.

Plan sponsors are hoping for further temporary funding relief from legislators. Otherwise, many companies will have to divert funds from critical business operations to make the contributions required under the Pension Protection Act of 2006 (PPA). At the time the PPA was passed, no one expected its funding provisions to take effect in today’s turbulent financial conditions. Absent such legislative relief, another round of pension plan freezes and closings might be around the corner. An increasing number of firms are suspending the match components of their defined contribution plans due to cash constraints.

¹See “Dramatic Drops in Interest Rates Forecast Much Lower DB Plan Funding Status on Accounting Basis for 2008,” Watson Wyatt Insider, February 2009, and “Year-End Pension Accounting Declines Might Be Milder Than Expected,” Watson Wyatt Insider, November/December 2008.
²Watson Wyatt top 100 consists of the 100 largest pension sponsors among U.S. publicly traded organizations, ranked by plan liability at year-end 2007. Historically, large plans are generally better funded than smaller plans, so the funding ratios in this analysis are larger than those in our earlier projections for the Fortune 1000.
³Three firms were missing data on expected contributions for 2009 and so were dropped from the analysis of plan contributions.