"Plan sponsors were hit hard with a double whammy in 2008 with severe market declines and new funding rules coming into effect," said David Speier, senior retirement consultant at Watson Wyatt. "This combination will require employers to make staggering pension contributions over the next couple of years, at a time when they can least afford them."
According to the analysis, pension contributions increased slightly last year - from $17.7 billion in 2007 to $18.4 billion in 2008. However, companies are expecting to make substantially larger contributions in 2009, up to more than $27.7 billion - a 50 percent increase over 2008 cash contributions. As many firms will not need to make their required contributions until 2010, this increase can be attributed to companies' making payments now to shore up funds in anticipation of future requirements.
Pension plan assets declined by 26 percent in 2008, largely due to significant equity losses. The percentage of a plan's portfolio invested in equities had a direct relationship with investment losses in 2008 - plans that had less than 20 percent of their portfolio in equities lost an average of 6 percent, while those with an equity allocation of 55 percent to 59.9 percent lost 23.6 percent. Those with an equity allocation of 90 percent or more lost 32.3 percent.
While stated equity targets have not declined significantly, actual equity allocations at year end were much lower. For the 83 companies that provided data, the average target equity allocation is 55 percent for 2009, compared with 58 percent for 2008. However, actual equity allocations fell over the year, to 48 percent at the end of 2008 from 59 percent the year before. Rather than a strategy shift, this reallocation was mostly due to the significant drop in the stock market - bonds significantly outperformed equities, thereby automatically shifting funds' asset distribution. It remains to be seen whether plans will redress this imbalance.
"Many pension plan sponsors have remained committed to equity investments as they have been expected to provide the best long-term returns," said Carl Hess, global head of investment consulting at Watson Wyatt. "However, the recent financial turmoil shows that large equity positions can create substantial risks. Companies can alleviate some of this risk by adopting liability-driven investment strategies, which utilize bond and derivative markets to better hedge their long-term pension liabilities, while at the same time making sure the overall risk level in their portfolio is one they can live with."
Other findings include:
* The distribution of funding ratios has significantly shifted in the past year. At the end of 2007, 80 percent of plan sponsors had realized funding levels of over 90 percent. By the end of 2008, only 14 percent were more than 90 percent funded.
* The average discount rate at year-end 2008 was 6.36 percent. More than half (55 percent) of plan sponsors used a higher discount rate in 2008 compared with 2007; 19 percent used the same rate assumption; and 26 percent used a lower rate.
