Solid Investment Returns Do Little to Close US Pension Funding Gaps

2010 was a solid year for institutional investment returns, and funds that have remained diligent in rebalancing their portfolios through the past two years made up considerable lost ground in terms of portfolio valuations. Despite this strong performance, the results of Greenwich Associates’ most recent US Investment Management Study reveal funding levels for corporate pension funds improved only modestly last year, while the solvency position of public pensions actually deteriorated.

US institutional investment portfolios generated average blended returns of 16% in 2010. That overall average includes a mean of 18% among corporate pension funds, 14% among public pension funds and 14% among endowments and foundations. That performance represents a strong recovery from 2009, when returns averaged -20% among corporate funds, -17% among public funds, and -19% among endowments and foundations.

“Funds that have consistently rebalanced probably regained about half the portfolio asset valuation lost during 2008-2009,” said Greenwich Associates consultant Dev Clifford.

However, these returns were not enough to bring about any dramatic improvements in the US pension plan funding ratios:

  • The average projected benefits obligation (PBO) of US corporate defined benefit (DB) plans increased to 83% in 2010 from 80% in 2009.
  • The largest corporate plans saw the greatest improvement in funding ratios, with average PBO among corporate plans with more than US$5bn in assets increasing to 89% from 84%.
  • The funding situation of public DB plans deteriorated from 2009 to 2010, with average solvency ratios declining to 76% from 83%.
  • Average solvency ratios dropped to 72% from 80% among state plans and to 77% from 84% among municipal plans.
  • The largest public DB plans – those with at least US$5bn in assets – saw average solvency levels dip to 78% from 81%.

“With rates at these historic lows, it would be difficult for any plan to make too much progress in terms of funding levels,” said Greenwich Associates consultant Chris McNickle. “But we are almost certainly heading for a rising interest rate environment that will cause funding ratios to improve – so plan sponsors can expect some level of relief.”

The other factor preventing a more robust increase in nationwide pension funding ratios was the inability or unwillingness of plan sponsors to increase contribution levels. Average cash contribution levels declined significantly from 2009 to 2010, probably reflecting the difficult and uncertain economic conditions faced by companies, states and municipalities. Corporate plan sponsors made cash contributions of 7-12% of plan assets in 2010; public plan sponsors made contributions of 4-5% on average. Both of these ranges are well below average contribution levels for 2008 and 2009.

With Return Expectations Falling, Funding Gap Could Widen

Forward-looking data on portfolio allocations and returns suggest the possibility for even wider funding gaps ahead. Both public and corporate funds have reduced their average actuarial earnings returns on plan assets – but only modestly so. Due to simultaneous reductions in expected rates of return in many major asset classes and shifts in allocation profiles, actual expected rates of plan return fall short of the actuarial earnings rate, resulting in a funding gap of 1.1% among corporate funds and 0.9% among public funds.

Corporate plan sponsors expect annual rates of return on plan assets to average 6.7% over the next five years. This average reflects a decline in return expectations to 7.2% from 8.0% in US equities and a decrease to 4.9% from 5.5% in fixed income. Public plan sponsors expect annual rates of return on plan assets to average 7.0% over the next five years, reflecting a big decline to 7.4% from 8.9% in US equities and a drop to 4.8% from 5.7% in fixed income.

Public Pension Funds Increase Allocations to Risky Investments

In aggregate, US institutions’ plans for future allocation shifts reveal a slight bias toward increasing domestic fixed income allocations in the next three years and a much bigger bias toward increasing allocations to hedge funds, equity real estate, private equity, international stocks and international fixed income. But a closer look at those numbers reveals clear differences in the investment strategies being pursued by different types of plan sponsors.

“The institutions planning big increases to US fixed income are mainly increasingly risk-averse corporate pension funds,” said Greenwich Associates consultant Andrew McCollum. “The group planning to increase allocations to high alpha products includes many public pension funds that are implementing aggressive allocation strategies in an effort to address pressing funding gaps.”


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