Milliman Consulting’s 2005 Pension Study reported earlier today that the top 100 US companies with defined benefit pension plans reported a 12.4% return on assets in 2004, nearly 50% higher than the 8.5% median expected return on those portfolios, which totaled some $1.023 trillion, according to the report.   That marked the second year of surplus gains, following three consecutive years of deficit returns during a period (2000 – 2002) frequently referred to as the “perfect storm” of soaring liabilities, steeply declining interest rates, and slumping asset values.   A year ago, Milliman reported that those top 100 plans enjoyed a 19.6% return (see  Milliman: Pension Assets Up 19.6% in 2003 ).  This year marks the fifth year Milliman has produced this study.

“Return to Normal”

Still, while the performance of the past two years could well be characterized as a “return to normal,” the nation’s private pension system is still struggling to recover from the damage wrought by the storm.   Consider that while the aggregate pension deficit decreased by another $10.4 billion in 2004 – on top of a $45.3 billion reduction in 2003 – that amounts to just a fraction of the $391.5 billion in surplus assets lost during the 2000 – 2002 period, according to Milliman.   Moreover, while more than 20% (22) of the top 100 companies were in a pension surplus position in 2004, two more than a year ago – that was still well short of the 85 in the pension funding black in 1999.  

Like a stunned boxer after a knockdown, those top 100 pension plans are slowly, sometimes painfully, picking themselves up off the mat.   According to Milliman, in 2004, the average funded ratio of those plans was 90.5%, up from 88.8% a year ago, and well up from the 82.6% average recorded in 2002.   With respect to accumulated benefit obligations, which do not take into account projected increases in future compensation, the aggregate funded ratio for the group rose from 95.6% in 2003 to 98.1% last year, according to Milliman.

Much of that gain has come the hard way, via increased contributions.   Milliman notes that a third of the companies surveyed increased their contributions in 2004 by more than 50%, while half as many decreased contributions by that amount following significant contributions in 2003.   Among the 59 firms that increased their contribution, the median increase was 57%.   Excluding General Motors (which contributed $19.1 billion in 2003 and just $0.9 billion last year (see  Back from the Brink? GM's Pension Works its Way Back to Funded Status ), Milliman notes that employer contributions increased to $40.7 billion from $37.8 billion in last year's report.

John Ehrhardt, a Principal and Consulting Actuary at Milliman, noted that the number of companies increasing their contributions in 2004 was actually a bit less than one might have expected - but told reporters in a press briefing that there was anecdotal evidence that some plan sponsors may have delayed making contributions last year based on word that the Bush Administration's pension reform proposal would restrict some of the accounting flexibility for carryforward on those contributions.

New Realities

Plan sponsors responded to some new market realities and reports of heightened regulatory scrutiny by reducing both the discount rates and expected rate of return assumptions in 2004.   The median discount rate used by the top 100 was just 5.75%, compared with 6.11% in 2003 (and 7.50% in 2000), while the median expected rate of return dropped to 8.50% from 9.50% in 2000.   Nearly half (45) of the firms lowered their expected rate of return, on top of the drop in assumptions made by three-quarters of the firms in 2003, according to Milliman, which drew its numbers from public financial statements of the firms.   Still, 20 companies continued to use an expected rate of 9.0%, a number that SEC staffers have indicated might require justification (see  Pension Reporting Draws SEC Criticism ).   The previous year 27 companies used an assumption above that level, while 70 did so in 2002 and 84 in 2001.

Those lower discount rates helped drive liabilities higher in 2004, increasing 8.3%, after increases of 11.4% in 2003, 10.8% in 2002, and 7.2% in 2001.  

Beyond changes in assumptions and some additional funding, plan sponsors evidenced no real shifts in their broad-based asset allocation strategies.   For the most part, the trend was to use income from fixed income investments to pay benefits, while the overall allocation to stocks moved from the low 60s to the high 60s, consistent with historical trends.   Shifts are occurring within those broad classes, with money moving from value to growth, and from domestic to international holdings, among other shifts, findings that echo the results of the 2004 PLANSPONSOR/Fidelity study of defined benefit plan practices (see  Funding Drives ).   

Asked about the frequently discussed idea of a shift of more assets to fixed income as a means of better matching assets to liabilities, Ehrhardt and John A. Cardinali, a senior consultant at Evaluation Associates, dismissed the notion.   "People are talking about it, but that's all," said Ehrhardt, noting that doing so for many would amount to locking in their pension expense, rather than benefiting from rising equity asset values to close that gap.   "Companies are still managing the level of their expense, not the volatility of that expense," Ehrhardt explained.

Milliman reiterated that the experience of the past two years constitutes a "return to the baseline," and noted that defined benefit plans should be expected to cost the employer at least 5-10% of payroll.   "The overfunded status of these plans during the 1990s was a temporary anomaly," according to the survey's authors.