Time Is Ripe for Pension Strategy Changes

In a stronger position, new choices are being made in the management of pensions in Russell Investments’ $20 billion club.

The $20 billion club consists of 19 corporations that together represent roughly 40% of the pension assets and liabilities of all U.S. publicly-listed corporations. Their combined pension deficit had been growing in recent years as interest rates have fallen. But 2013 saw a sharp reversal of that pattern, with more than $100 billion wiped off of the deficit thanks to strong asset performance and a rise in interest rates of almost 0.9%.

According to Bob Collie, FIA, chief research strategist of Americas Institutional at Russell, the median discount rate used to value U.S. plan liabilities—which had fallen from 6.4% to 4.0% in the previous four years—rose to 4.89%. This alone accounted for a gain of some $69 billion. Helped by another strong year on the asset side and plans sponsor contributions, this meant that over 40% of the deficit was wiped out; the net shortfall of assets below liabilities fell by some $106 billion.

Investment returns—which totaled almost 9%—comfortably outpaced the interest cost on liabilities. Contributions from plan sponsors were around $27 billion, which was almost double the value of new benefit accruals. While only Bank of America has worldwide pension assets in excess of liabilities, that goal is now within sight for a number of these corporations.

“This improved position is affecting how plans are being managed,” Collie says in a recent article. Smaller shortfalls mean smaller contributions, less investment risk and a growing emphasis on defined contribution.

From a low of $12 billion in 2008 (less than the value of new benefit accruals that year), plan sponsor contributions averaged more than $25 billion a year from 2009 to 2013 due to catch-up contributions required as a result of the losses of 2008. But as deficits shrink, the need for continued catch-up contributions also shrinks.

MAP-21 may also have some effect on contribution levels in 2014 (see “The Impact of MAP-21”). As a result, expected contributions for 2014 disclosed in the latest reports came to some $14.3 billion. “With a combined total shortfall of $114 billion, catch-up contributions will continue to be required from several of these corporations for the next few years, but probably not at the level that seemed likely a year ago,” Collie says.

With the improved funding position, many plans are moving to liability-driven investing (LDI). For example, according to Collie, Ford’s 10-K filing with the Securities and Exchange Commission notes that they have “adopted a broad global pension derisking strategy” as a result of which they expect to reach an 80% fixed income allocation in the U.S. “over the next few years as the plans achieve full funding”. In a similar vein, United Technologies’ 10-K notes that “the interest rate hedge is dynamically increased as funded status improves.”

Collie points out that one observation that came out of last year’s analysis of the $20 billion club was that the 2012 liability value of $915 billion was possibly as large as the liabilities were ever going to get. “Those liabilities fell by more than $73 billion in 2013 and, barring a substantial drop in interest rates, it looks like 2012 was indeed ‘peak pension’: America’s private sector defined benefit system is now officially shrinking,” he says.

As of the end of 2012 (the most recent publicly available data) the defined contribution plans of the $20 billion club totaled about $400 billion in the U.S. alone; less than the defined benefit assets of these corporations, but catching up fast. “The $20 billion club is a club that was chosen based on the size of defined benefit plans, but even here we see the steady rise of DC,” Collie says.

The 19 corporations that make up the $20 billion club are AT&T, General Electric, Northrop Grumman, Bank of America, General Motors, Pfizer, Boeing, Dow Chemical, Hewlett-Packard, Honeywell, Raytheon, United Parcel Service, E.I. DuPont de Nemours, IBM, United Technologies, Exxon Mobil, Lockheed Martin, Verizon Communications and Ford.