Resulting Funding Gap Could Be "Final Stake in the Heart" Of U.S. Defined Benefit Pensions
Thursday, January 29, 2009 Stamford, CT USA — U.S. pension funds are projecting sharply reduced investment returns from major asset classes through 2013, according to new research from Greenwich Associates.
Every year, Greenwich Associates asks more than 1,000 U.S. institutions to disclose the annual rates of return they are expecting on individual asset classes for the next five years. Overall, corporate pension funds interviewed from July to October 2008 said they had reduced investment returns on plan assets to an annual 7.4% in 2008 from 8.2% in 2007 and public funds cut overall portfolio return expectations to 7.6% from 8.5%.
"U.S. pension funds are not expecting a quick recovery in investment markets," says Greenwich Associates consultant William Wechsler. "To the contrary, they are planning for a slow-growth environment for asset valuations that they expect to continue for the next five years."
Pension funds have dramatically reduced return expectations for U.S. equities, with projections for annual rates of return dropping to 7.8% in 2008 from 8.6% in 2007 among corporate plans and to 7.9% from 9.1% among public plans. Both groups also cut return expectations on fixed income, with public plans reducing annual expectations to 5.0% from 5.8% and corporate plans reducing expected returns to 5.2% from 5.6%. Pension funds also reported substantial reductions in expected returns on international equity, equity real estate, private equity and hedge funds.
Both groups expected private equity to generate the highest returns of any asset class over the next five years, with public funds projecting an annual 11.3% return from their private equity investments and corporate funds expecting 10.1%. "It is important to remember the extent to which markets have deteriorated since these interviews were completed in September," says Greenwich Associates consultant Dev Clifford. "If anything, these expectations for private equity and other asset classes might prove overly optimistic."
A Stake in the Heart of Corporate Defined Benefit Pensions?
Declines in investment returns have produced a gap between pension funds' actuarial earnings rate and their actual expectations for returns on plan assets. The average actuarial earnings rate reported by corporate pension plans increased modestly to 8.3% in 2008 from 8.2% in 2007 despite the decline in expected returns for all asset classes. The discrepancy results in an expected gap of 90 basis points. Although the average actuarial rate for public plans declined to 8.0% in 2008 from 8.2%, the bigger drop in expected investment returns has produced a gap of 40 basis points.
"These gaps can only be made up in one of two ways: through higher investment returns or new contributions," says Greenwich Associates consultant Chris McNickle. "At the present moment, neither option seems particularly likely. So we are facing a growing problem."
The results of the annual Greenwich Associates study suggest that institutions believe a low return environment will persist for some time to come. Meanwhile, companies, states, municipalities and other plan sponsors are facing severe resource constraints. Rather than being in a position to increase contributions, many plan sponsors are reducing or delaying contributions as part of actions that will save them money in the short term, but these actions could serve to increase pension funding shortfalls over the long term. Some will be at risk of violating regulatory requirements, and in the current environment may seek relief from the government.
"We might look back at this crisis as being the final stake in the heart of corporate defined benefit pension plans in the United States," says William Wechsler. "Recent volatility in pension asset valuations is bringing home the risks these plans can pose to the bottom line, and unfortunately closing plans to new employees is a relatively easy way for companies to reduce pension costs."
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