Mercer Foresees Dismal Outlook for Pension Plan Contributions and Expense

The outlook for 2012 pension plan contributions and expense is bleak, a new Mercer analysis shows, with the aggregate deficit in pension plans sponsored by S&P 1500 companies decreasing by $80 billion during November. 

(December 18, 2011) — The outlook for 2012 pension plan contributions and expense is bleak, according to consulting giant Mercer. 

“Even though discount rates moved somewhat higher during November, they are likely to be in excess of 40 basis points lower at the end of this year than they were at the end of 2010,” said Kevin Armant, Principal in Mercer’s Financial Strategy Group, in a statement. “Because equities have also underperformed expectations, corporations who use a December 31 measurement date will likely see larger pension liabilities on their balance sheet, as well as higher 2012 pension expense.” 

According to Mercer’s analysis, the aggregate deficit in pension plans sponsored by S&P 1500 companies decreased by $80 billion during November — falling from a deficit of approximately $471 billion as of October 31, to $391 billion as of November 30.

The increase in funded status was fueled by an increase in yields on high quality corporate bonds during November, Mercer revealed in a statement. Despite previous losses, equity markets ended the month strong, resulting in a final loss for the month of only 0.2%. Meanwhile, discount rates for the typical US pension plan increased approximately 40 basis points during the month.

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Craig Rosenthal, Partner in Mercer’s Retirement, Risk and Finance business, added: “Plan sponsors also need to consider the impact of the falling interest rates and flat equity returns on 2012 contribution requirements. We had already anticipated the potential for large contribution increases due to declining interest rates, but if we end the year end with equity markets where they were at the end of November there could be even higher contributions for 2012 and beyond than were previously anticipated.”

In October, Mercer revealed that the funded status for most pension plans is anticipated to drop significantly with plan sponsors facing sharply higher contributions for 2011 and beyond. “Falling interest rates have created an environment in which plan sponsors that have taken steps to de-risk — incorporating a liability-driven investing approach — have fared better than those who haven’t,” Rosenthal told aiCIO in October. Rosenthal described the current market environment as a ‘pension perfect storm,’ characterized by declines in asset values, driven mainly by equities, coupled with growing liabilities due to falling interest rates. Amid the turbulent environment, the trajectory for cash contributions continues to point skyward, according to Rosenthal. “These dramatically increasing contributions could drive some employers out of the pension system,” he said. 

In anticipation of a worsening pension perfect storm, Rosenthal added that many of Mercer’s clients with the luxury of available cash have made additional voluntary contributions for the 2010 plan year so that their 2011 funded ratios would avoid further threshold tests and scrutiny, as mandated by the Pension Protection Act (PPA).

Low interest rates have been driven largely by US economic policy, and Mercer noted that “the full effects of this one-two punch won’t be fully felt until 2012 and beyond.” Huge and continuing cash calls, the slow economic recovery, and big potential increases in Pension Benefit Guaranty Corporation (PBGC) premiums under consideration in Congress could place many plan sponsors in a difficult position, the firm stated in a release, adding that without changes to pension funding rules, the funded status for many plans in 2011 and subsequent years will likely continue to decline significantly, with the following implications:

1) Funded ratios fall

2) Required contributions soar

3) Credit balances wither

4) Cash contributions skyrocket – up eightfold in just two years

5) Additional contribution increases expected in 2012

Video: Craig Rosenthal, partner at Mercer, anticipates soaring 2011 contributions for pension plan sponsors as interest rates hit record lows.