Milliman analysis: January 2015 interest rates reach a record low of 3.38% with abysmal effect on pension funding
Milliman 100 PFI collapses to 79.6%.
The funded status of the 100 largest corporate defined benefit pension plans dropped by $90 billion during January as measured by the Milliman 100 Pension Funding Index (PFI). The $90 billion funded status decline was the eighth largest monthly drop in the 15-year history of the Milliman 100 PFI. The funded status deficit ballooned to $382 billion from $292 billion at the end of December 2014 due to the 42 basis point decline in the benchmark corporate bond interest rates used to value pension liabilities. Pension assets had a monthly above-expected return due to strong fixed income asset return and this helped to counter liability losses. As of January 31, the funded ratio decreased to 79.6%, down from 83.5% at the end of December 2014. The previous sub-80% PFI funded ratio was in December 2012.
The projected benefit obligation (PBO), or pension liabilities, increased to $1.876 trillion from $1.775 trillion at the end of December 2014. The change resulted from a decrease of 42 basis points in the monthly discount rate to 3.38% for January from 3.80% for December 2014. January’s discount rate is the lowest in the history of the Milliman 100 PFI.
The last time we observed a comparable discount rate change was in July 2012 when discount rates fell 40 basis points ending at 3.92%. January’s precipitous drop is even more impactful.
The market value of assets increased by $11 billion as a result of January’s investment return of 1.07%. The Milliman 100 PFI asset value rose to $1.493 trillion. By comparison, the 2014 Milliman Pension Funding Study reported that the monthly median expected investment return during 2013 was 0.60% (7.4% annualized).
The expected rate of return for 2014 will be updated in the 2015 Milliman Pension Funding Study due out later in the first quarter of 2015.
Over the last 12 months (February 2014 – January 2015), the cumulative asset return for these pensions has been 11.04%, but the Milliman 100 PFI funded status deficit has deteriorated by $135 billion. The reason for the drop in funded status in spite of asset returns above expectations was the declining interest rates experienced during most of 2014. The funded ratio of the Milliman 100 companies has decreased over the past 12 months to 79.6% from 84.9%.
December 31 pension disclosures are expected to reflect adoption by many plan sponsors of new mortality assumptions which generally reflect increases in life expectancy, resulting in higher pension liabilities. The magnitude of these increases depends on the age, gender, and composition of annuitants and non-annuitants by individual pension plan. The February Milliman 100 PFI has not been adjusted to estimate the increase in PBO to reflect the mortality tables finalized by the Society of Actuaries last October. However, our preliminary analysis of the impact indicates an estimated increase of 6% to 8% in pension liabilities. This would imply a PBO increase of up to $151 billion and would decrease the funded ratio by over six percentage points, bringing it 73.6%, a funding level last seen in October 2012.
Additionally, the projected asset and liability figures presented in this analysis will be adjusted as part of our annual 2015 Pension Funding Study where pension settlement and annuity purchase activities that occurred during 2014 will be reflected. De-risking transactions generally result in reductions in pension funded status because the assets paid to the participants or assumed by the insurance companies as part of the risk transfer are larger than the corresponding liabilities that are extinguished from the balance sheets. To offset this decrease effect, many companies engaging in de-risking transactions make additional cash contributions to their pension plans to improve the plan’s funded status.
If low discount rates are sustained, the only two ways for the funded status to improve are by exceptional investment returns and higher cash contributions by plan sponsors, the latter of which is expected to remain relatively low given the contribution funding relief implemented by the Highway and Transportation Funding Act, passed in August 2014. Pension plan accounting information disclosed in the footnotes of the Milliman 100 companies’ annual reports for the 2014 fiscal year is expected to be available during the first quarter of 2015 as part of the 2015 Milliman Pension Funding Study.
If the Milliman 100 PFI companies were to achieve the expected 7.4% (as per the 2014 Milliman Pension Funding Study) median asset return for their pension plan portfolios and the current discount rate of 3.38% was maintained during years 2015 and 2016, we forecast that the funded status of the surveyed plans would increase. This would result in a projected pension deficit of $347 billion (funded ratio of 81.5%) by the end of 2015 and a projected pension deficit of $308 billion (funded ratio of 83.7%) by the end of 2016. For purposes of this forecast, we have assumed 2014 aggregate contributions of $44 billion and 2015 and 2016 aggregate contributions of $31 billion.
Under an optimistic forecast with rising interest rates (reaching 3.93% by the end of 2015 and 4.53% by the end of 2016) and asset gains (11.4% annual returns), the funded ratio would climb to 91% by the end of 2015 and 104% by the end of 2016. Under a pessimistic forecast with similar interest rate and asset movements (2.83% discount rate at the end of 2015 and 2.23% by the end of 2016 and 3.4% annual returns), the funded ratio would decline to 73% by the end of 2015 and 66% by the end of 2016.
About the Milliman 100 Monthly Pension Funding Index
For the past 14 years, Milliman has conducted an annual study of the 100 largest defined benefit pension plans sponsored by U.S. public companies. The Milliman 100 Pension Funding Index projects the funded status for pension plans included in our study, reflecting the
impact of market returns and interest rate changes on pension funded status, utilizing the actual reported asset values, liabilities, and asset
allocations of the companies’ pension plans.
The results of the Milliman 100 Pension Funding Index were based on the actual pension plan accounting information disclosed in the
footnotes to the companies’ annual reports for the 2013 fiscal year and for previous fiscal years. This pension plan accounting disclosure
information was summarized as part of the Milliman 2014 Pension Funding Study, which was published on April 2, 2014. In addition to
providing the financial information on the funded status of U.S. qualified pension plans, the footnotes may also include figures for the
companies’ nonqualified and foreign plans, both of which are often unfunded or subject to different funding standards than those for U.S.
qualified pension plans. They do not represent the funded status of the companies’ U.S. qualified pension plans under ERISA.