The upheaval on Wall Street that began a few weeks ago is the latest
chapter in the financial market turmoil that began in the middle of last
year. Since the end of 2007, the funded status of pension plans
sponsored by large US companies has fallen by almost $100 billion.
However, during the third quarter, despite the falls in global equity
markets, the financial position improved, due to the increase in “high-quality”
corporate bond yields, according to analysis conducted by Mercer.
The ratio of plan assets to plan liabilities, which was 104 percent at
the end of 2007, was 97 percent at the end of the third quarter. The
surplus at the end of 2007 of $60 billion has been replaced by a deficit
of $35 billion. However, Mercer’s analysis
shows that without a significant increase in high-quality corporate bond
yields, which are used by most companies to measure the value of plan
liabilities, the financial position would be significantly worse.
Furthermore, if credit spreads return to levels typically observed over
the last three to four years, without a recovery in equity values, the
deficit could open up to over $400 billion.
Mercer estimates the total combined funded status position of plans
operated by S&P 1500 companies on a monthly basis. It examines the
estimated surplus/deficit position and the funded status (ratio of
assets to liabilities) of all plans operated by companies in the S&P
1500 as reported in their financial statements. The analysis includes US
domestic qualified and nonqualified plans and all non-domestic plans.
“It is important to understand the
relationship between corporate bond yields and pension plan liabilities,”
said Adrian Hartshorn, a member of Mercer’s
Financial Strategy Group, which helps companies manage financial risk in
their retirement programs. “Pension plan
liabilities are a promise of payments in the future, and are therefore
similar to bonds, albeit with a more complex structure. Also, like all
bonds, an increase in the discount rate – in
this case the yield on corporate bonds –
reduces the present value of pension plan liabilities.”
Mr. Hartshorn continued: “Although there has
been a significant reduction in the funded status of pension plans over
the year – from 104 percent to 97 percent –
had there not been an increase in credit spreads the position would be
worse. Between 2003 and 2007, credit spreads between AA corporate bonds
and US Treasuries were typically 1–1½
percent, but are currently [at the end of
September] standing at over 3.3 percent. If
markets settle and credit spreads contract to previous levels without a
recovery in the equity markets and without any other external events,
the funded status of pension plans would fall to 77 percent, equivalent
to a deficit of over $400 billion. This would clearly be bad news for
sponsors of defined benefit plans, and would lead to higher pension
costs in financial statements and higher cash contribution requirements.”
Mr. Hartshorn outlined several steps plan sponsors should take in
response to the current market conditions.
“Plan sponsors should continue to educate
themselves on the risks they are exposed to with their pension plans,”
Mr. Hartshorn said. “Those who have
quantified and can withstand short-term volatility are being encouraged
to sit tight and maintain a longer term focus. Others may be revisiting
their current program financial management policies and considering
opportunities to mitigate risk or better position themselves moving
forward. While it is difficult to take short-term action, it is also
important for plan sponsors to monitor the ever-changing environment and
be prepared to take action at the appropriate time.”
Mr. Hartshorn added, “As we approach the
financial year end for many companies, continued market volatility could
result in substantial, unplanned and potentially unwelcome outcomes for
plan sponsors in terms of accounting figures and future cash flow
requirements. This would suggest updating budget forecasts for 2009
expense and cash, and then monitoring the position closely until the end
of the year.”
A complete analysis of third-quarter pension volatility will be
available on Mercer.com shortly. On Oct. 14 Mercer will host a webcast
on the implication of recent market volatility for the finances of
pension plans and the impact on corporate budgets for 2009. To attend,
please register at http://www.mercer.com/referencecontent.htm?idContent=1323980.
Notes for Editors
The calculations are based on the Financial Accounting Standard (FAS)
funding position and include analysis of the S&P 1500 companies.
About Mercer
Mercer is a leading global provider of consulting, outsourcing and
investment services. Mercer works with clients to solve their most
complex benefit and human capital issues, designing and helping manage
health, retirement and other benefits. It is a leader in benefit
outsourcing. Mercer’s investment services
include investment consulting and multi-manager investment management.
Mercer’s 18,000 employees are based in more
than 40 countries. The company is a wholly owned subsidiary of Marsh &
McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on
the New York, Chicago and London stock exchanges. For more information,
visit www.mercer.com
.
Mercer
Stephanie L. Poe, 202-331-5210
Stephanie.Poe@mercer.com
