United States
New York , 1 September 2010

US pension plan funded positions have fallen to historic lows during August due to simultaneously falling equity markets and interest rates. The August decline erased modest gains made in July and pushed the health of pension plans, as measured on a mark-to-market basis, to all-time lows.

The deficit in pension plans sponsored by S&P 1500 companies increased by $76 billion to $506 billion at the end of August according to new figures from Mercer . This pension plan shortfall is the largest ever recorded by S&P 1500 companies and is also more than double their 2009 year-end deficit of $247 billion.

The end-of-August deficit corresponds to a funded status of 71%, compared to a funded status of 75% at the end of July and 84% on December 31, 2009. “If the low funded status persists until the end of 2010 when two-thirds of companies have their financial years end, net balance sheet liabilities and income statement expense for 2011 will increase significantly for many companies. Cash contributions will also need to increase to reduce the deficit,” said Gordon Young, the Integrated Retirement Financial Management leader for Mercer in the US. “Some of this may be mitigated by various smoothing methods and pension funding relief, but nonetheless these market conditions will certainly grab the attention of plan sponsors.”

For most of 2010, equity values have experienced significant volatility. For example, equity returns were up 7% in July and down 5% in August. In addition to equity volatility, there remains concern over the level of the AA bond yield, which has been steadily declining in 2010, reaching 4.94% (for a mature plan) as of the end of August, the lowest yield in a decade. Because pension plan liabilities are valued using the AA bond yield, these lower yields translate into higher plan liabilities.

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“The last several months have reminded us that financial risk is inherent in pension plans. Increasing deficits caused by volatility in both the equity and bond markets highlights the inherent risk in the investment strategies being pursued by many companies. Plan sponsors should understand that they need a sound plan to measure and manage this risk. In the absence of sound risk management plan sponsors will experience recurring episodes of financial pain and temporary relief in their pension plan due to market fluctuation,” said Mr. Young.

Relatively large swings in the funded status of pension plans, as witnessed the past several months, can occur when there is a significant mismatch between the way that assets are invested and the way that liabilities are valued. For example, changes in the value of equities are largely uncorrelated with changes in the value of liabilities, so that a plan sponsor with a material pension plan investment allocation to equities can expect funded status and cash contribution requirements to be volatile.

“Over the past several years there has been an increasing trend to implement investment strategies that result in higher correlation between how assets and liabilities behave, thus hedging more of the funded status risk. We think this trend will only accelerate given the current market conditions. Also, we believe that increasingly plan sponsors, especially those with mature plans, will be seeking to implement specific strategies to dynamically reduce pension plan financial risk over time,” said Mick Moloney, Senior Partner and global leader of Mercer’s Financial Strategy Group.

Mercer estimates the aggregate combined funded status position of plans operated by S&P 1500 companies on a monthly basis. Figure 1 shows the estimated aggregate surplus/deficit position and the funded status of all plans operated by companies in the S&P 1500. This is based on projections of their reported financial statements  adjusted from each company’s financial year end to August 31 in line with financial indices. This includes US domestic qualified and non-qualified plans and all non-domestic plans. The estimated aggregate value of pension plan assets of the S&P 1500 companies at December 31, 2009, was $1.25 trillion, compared with estimated aggregate liabilities of $1.50 trillion. Allowing for changes in financial markets though the end of August 2010, changes to the S&P 1500 constituents and newly released financial disclosures, the estimated aggregate assets were $1.27 trillion, compared with the estimated value of the aggregate liabilities of $1.77 trillion.

Notes for Editors
Unless otherwise stated, the calculations are based on the Financial Accounting Standard (FAS) funding position and include analysis of the S&P 1500 companies.

Information on the Mercer Yield Curve is available at: www.mercer.com/pensiondiscount. 

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.