Defined benefit (DB) pension plans continue to weigh on the financial health of the organizations who offer them, according to a report by Towers Watson.
“DB plan sponsors will continue to feel the impact of the double-whammy we experienced in 2011 — a combination of declining long-term interest rates and poor equity market performance,” said Ian Markham, Canadian retirement innovation leader at Towers Watson. “For many organizations, these conditions have resulted in larger plan deficits at the end of 2011 and will lead to higher pension costs in 2012 and beyond.”
The Towers Watson DB Pension Index tracks the performance of a hypothetical DB pension plan that was fully-funded in the plan sponsor’s financial statements at the end of 2000. The financial health of the plan is tied to two important measures — investment returns, which boost the amount of assets held in the pension fund, and the level of long-term interest rates on corporate bonds, which determines the amount of assets that are theoretically needed today to pay the future benefit promises made to current plan members.
The combined effects of poor investment returns and decreasing interest rates during 2011 caused the index to fall 16.2 per cent, found the report. This would mean that the typical DB plan, which was 86 per cent funded on an accounting basis at the start of 2011 (the median of a database of companies being tracked), will find itself at only 72 per cent funded at the end of the year, unless the plan sponsor has made additional contributions during the year to shore up the plan’s financial health, said Towers Watson.
Last year was a difficult year for investors, and in particular for pension plans. The typical 60-40 allocation of pension plan assets to stocks and bonds used for the index would have only generated 0.5 per cent returns over 2011, while pension plan liabilities would have increased by close to 20 per cent due to the decline in interest rates over the same period, said Towers Watson.
“DB plan sponsors are acutely aware of the downward trend in interest rates, and potential volatility in the stock markets. In response, many have already taken steps to reduce the size of their DB pension liabilities,” said Roland Pratte, a senior investment consultant at Towers Watson. “For 2012, plan sponsors should continue to work on managing their pension financial risks with focus on both the investment and plan design fronts, and paying careful attention to their ongoing plan funding strategies.”
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