The average funding ratio for the 100 largest U.S. corporate defined benefit plans jumped to 93.5% in 2013 — more than 10 percentage points higher than the previous two years and the highest since 2007, according to Pensions & Investments‘ annual analysis of corporate SEC filings.
“I would not be surprised if the funding ratio exceeded 100% by the end of this year,” said Andrew Wozniak, the New York-based head of fiduciary solutions, in the investment strategy and solutions group of BNY Mellon Investment Management.
The funding level was 108.6% in 2007, but plunged to 79.1% in 2008, the peak of the financial crisis. In 2012, funding was 80.6%, a slight decrease from 2011’s 81.6%.
The aggregate funding deficit of the largest 100 plans shrank to $122.3 billion in 2013, from a deficit of $301.6 billion in 2012.
“We were pleased to see a rise in funded status in 2013,” said Alan Glickstein, Dallas-based senior retirement consultant atTowers Watson & Co. However, Mr. Glickstein noted the relatively high discount rates used to calculate plan liabilities in 2013 were “still well below where rates were before the financial crisis.”
The average discount rate rose to 4.82% in 2013 — higher than the 4.05% for 2012 but lower than the average of 6.4% used in 2008.
“For years, people have expected rates to rise,” said Justin Owens, asset allocation strategist at Russell Investments in Seattle. “2013 was the year when interest rates finally rose.”
Strong performance in equity markets also played a big part in the 2013 increase. The Russell 3000 index gained 33.6% in 2013, while the Standard & Poor’s 500 returned 32.4%. International equities also showed higher returns in 2013, with the MSCI World index ex-U.S. returning 21.6%.
Fixed income did not fare as well. The Barclays U.S. Aggregate index returned -2% in 2013, while the Barclays Global Aggregate ex-U.S. index returned -3.1%.
The lower fixed-income returns in 2013 are not expected to cause a change in asset allocation strategies. “You just care about the stability of your plan’s funding,” said Towers Watson’s Mr. Glickstein. “Looking at it in the context of liability-driven (investing) or liability matching, you are less concerned with beating the market and more concerned with smoothing out volatility.”
Aggregate assets of the top 100 plans increased to $1.16 trillion in 2013, a $53.9 billion increase from the previous year.
“2013 was a fantastic year for plan sponsors of corporate defined benefit plans,” said BNY Mellon’s Mr. Wozniak. “A strong equity market is the other half of the story.”
97 boost funded status
In an environment of higher interest rates, lower plan liabilities and higher equity returns, 97 plans increased their funded status in 2013, while 24 plans had a funding surplus, four more than in the previous year.
The Allstate Corp., Northbrook, Ill., with $5.6 billion in defined benefit assets, had the highest jump in funded status, rising to a funding ratio of 105.8% in 2013 from 80.2% in 2012. In addition to a higher discount rate and a more favorable equity market, the company’s 10-K filing also cited a $479 million increase in the pension prior service credit during 2013, which resulted from changes to the plan’s benefit formula.
The highest funding ratio — 163.8% — once again was held by NextEra Energy Inc., Juno Beach, Fla., with $3.69 billion in assets and $2.25 billion in liabilities. In 2012, Next-Era Energy’s funding ratio was 142.7%. According to notes in the company’s 10-K filing, NextEra Energy works to maintain its plan’s funded status to minimize future company contributions.
Mr. Wozniak of BNY Mellon sees maintaining a balance between assets and projected liabilities as a forward-looking strategy for corporate plan sponsors. “They would rather have the surplus cover that,” he said, “so they won’t have to write a check in the future.”
MeadWestvaco Corp., Richmond, Va., had the next highest funding ratio at 161.2%, up from 141.4% in 2012. The company used a 2013 discount rate of 4.82%, reducing liabilities to $2.4 billion from $3.03 billion the previous year. The company had defined benefit assets of $3.9 billion in 2013.
The remaining three of the top five highest-funded plans were financial services companies. BB&T Corp., Winston-Salem, N.C., had a funding ratio of 153.2%, with $3.73 billion in assets and $2.43 billion in liabilities. J.P. Morgan Chase & Co., New York had a funding ratio of 133.2%, with $14.35 billion in assets and $10.78 billion in liabilities, and Bank of America Corp., New York, had $18.28 billion in assets, $14.15 billion in liabilities and a funding ratio of 129.2%.
Bank of America also had the second-highest increase in funded status, with a 25.2 percentage-point increase from 2012. Bank of America froze its defined benefit plans effective June 30, 2012, and the company’s 10-K filing cited remeas–ure–ment of plan assets and liabilities after the freeze as a contributing factor to the funded status increase.
“Sponsors will continue to shed liabilities — adding a lump sum, cashing out, fully or partially terminating the plan,” said Mr. Wozniak of BNY Mellon.
When categorized by sector, financials had the highest average funding ratio — 107.1% — in 2013, with 14 companies in the sector. Next was health care, with an average funding ratio of 97.6% for eight plans.
The highest funding ratio in the health-care sector belonged to Merck & Co. Inc., Whitehouse Station, N.J. With $17.4 billion in assets and $16.06 billion in liabilities, Merck had a 21.6 percentage-point increase in funded status, rising to 108.6% in 2013 from 87% in 2012.
Two airlines found themselves at the other end of the funding spectrum. Delta Air Lines Inc., Atlanta, had the dubious honor of sponsoring the worst-funded plan of the top 100 for the ninth consecutive year. Delta had a funded ratio of 46.9%, with plan assets of $8.9 billion and liabilities of $19.1 billion. Delta contributed $914 million to its plans in 2013. In 2012, Delta had a funded ratio of 38.1%.
American Airlines Inc., Fort Worth, Texas, was third lowest on the list, with $10.06 billion in assets and $14.9 billion in liabilities for a funding ratio of 67.5% in 2013. American Airlines increased contributions to $494 million in 2013, which contributed to a $996 million reduction in plan liabilities.
Decreased contributions were a noticeable trend among the top 100 companies in 2013, with contributions at the lowest level since the peak of the financial crisis in 2008. “We expect to see lower contributions,” said Bob Collie, chief research strategist, Americas institutional, at Russell Investments, Seattle. “It’s interesting to look at the impact of funded status on contributions.”
Although some companies made voluntary contributions above requirements, many followed a policy of contributing the minimum amount to gain tax advantages and comply with regulatory requirements. “In aggregate, this sample of very large plans is pulling back on contributions,” said Mr. Glickstein.
The plans in P&I‘s universe made contributions of $31.7 billion in 2013, down from $47.4 billion in 2012. Five companies contributed $1 billion or more in 2013.
Ford Motor Co., Dearborn, Mich., was the top contributor, putting $3.54 billion into its plans in 2013. With $41.22 billion in assets and $43.18 billion in liabilities, Ford’s 2013 funded status was 95.4%. Ford reduced its liabilities by offering some participants a one-time choice to receive a lump-sum benefit settlement. According to its 10-K, Ford settled obligations of $3 billion in 2013 through the lump-sum offers, an option more plans might pursue as funding ratios rise.
“The funding level has improved,” said Mark Ruloff, director of asset allocation at Towers Watson in Arlington, Va. “They are definitely more inclined to derisk, whether through an investment strategy move or a buyout.”
Lockheed Martin Corp., Bethesda, Md., contributed $2.25 billion in 2013 to place second on the contribution list. The company had $33.01 billion in assets and $42.16 billion in liabilities in 2013 for a 78.3% funding ratio, 11.1 percentage points higher than in 2012.
Boeing Co., Chicago, contributed $1.54 billion in 2013, reaching a funded status of 84.7%. Boeing had $58.13 billion in assets and $68.63 billion in liabilities. Boeing contributed more than $1.5 billion in 2013 but expects required contributions to be minimal in 2014. According its 10-K filing, the company plans discretionary contributions of about $750 million.
Raytheon Co., Waltham, Mass., contributed $1.08 billion, with a funded status of 84.9%, $18.82 billion in assets and $22.16 billion in liabilities in 2013. With a funding ratio of 80.3%, a 19.6 percentage point increase from 60.7% in the previous year, Goodyear Tire & Rubber Co., Akron, Ohio, made $1.02 billion in contributions in 2013.
The top 100 companies have announced contribution plans of $21.09 billion so far for 2014. According to annual filings, Ford, Exxon Mobil Corp., Goodyear Tire & Rubber, Verizon Communications Inc. and Lockheed Martin Corp. expect to make contributions of more than $1 billion each.
The Moving Ahead for Progress in the 21st Century Act, which reduced required minimum contributions, will continue to have an impact in 2014. “It’s still relevant,” said Mr. Wozniak. “Sponsors still have an option to defer some of the funding to future years. It gives them more flexibility.”
In terms of investments, allocations to most asset classes were largely unchanged from the previous year. The weighted average allocation to equities was 37.6% in 2013, up from 36.5% in 2012. The allocation to fixed income fell to 38.4% from 40.1% in 2012 and 40.7% in 2011.
Russell’s Mr. Collie cited funded status as “the single biggest force driving asset allocation. This is a big change in the last five years, the extent to which the funded status and asset allocation targets are tied together.”
Although the weighted average allocation to fixed income was lower among the plans in P&I’s universe, many have committed to derisking strategies that focus on fixed-income securities.
In anticipation of an April 30 freeze on future benefit accruals for hourly U.S. pension plans, Goodyear plans to change its target asset allocation to a portfolio of substantially all fixed-income securities, according to its 10-K. Goodyear had a 55.1% allocation to fixed income in 2013, up from 31.8% in 2012. The change is “designed to offset the future impact of discount rate movements on the plans’ funded status,” the 10-K said.
Russell’s Mr. Owens said funded status will act as a trigger for plans to make asset allocation changes. “Moving more toward fixed income is an industry standard,” he said. “I’m seeing more going toward that path.”
Fees can be an additional factor in derisking choices, said BNY Mellon’s Mr. Wozniak. “Assessing fee productivity, am I, as a sponsor, getting value after fees? To the extent that you are not getting that value, sponsors are considering smart beta, indexing or other investment approaches.”
The average expected long-term rate of return on plan assets decreased to 7.55% in 2013, down from 7.73% in 2012 and 7.94% in 2011.
“If there is a spike in the volatility of currency, it might catch some investors by surprise,” said Mr. Wozniak. “I would encourage sponsors to be thinking about that. In terms of risks, what could go wrong? Growth or earnings disappointments, a spike in energy prices, an unexpected increase in inflation, or there could be geopolitical risk.”
Mr. Owens of Russell was more philosophical. “There’s still a long journey ahead,” he said.
Source: Pensions & Investments