Shareholder Equity Impact of New Pension Fund Accounting Rules Not as Dire as Predicted, According to Mercer Analysis of S&P 500 Plans

Business Wire, August 8, 2007

* Strong asset returns and a rise in discount rates helped increase median funded status for S&P 500 plan sponsors to 89% in 2006, up from 83% in 2005.

* FAS 158, the new financial accounting standard for retirement plans, did not adversely affect shareholder equity as much as predicted last year.

* Jury out on whether plan sponsors will move to less risky investments to preserve gains in funded status. Market volatility since mid-July illustrates equity risks.

NEW YORK -- The improved financial health of major corporate pension plans significantly reduced the need for plan sponsor contributions in 2006, according to a new analysis by Mercer Human Resource Consulting and Mercer Investment Consulting. In addition, the improved funded status of pension plans lessened the impact of the switch to new accounting rules, which require full balance sheet recognition of plan deficits.

Among companies in the S&P 500, the funded status of pension plans - the ratio of plan assets to liabilities - increased to 89% in 2006 from 83% in 2005, Mercer said. As of the end of 2006, plan sponsors had not yet moved to make significant changes in investment to consolidate these gains, preferring to continue to take equity risks in the hope of higher expected returns.

In its report, How does your retirement program stack up?, Mercer analyzes retirement plan data disclosed by the S&P 500 companies in their 10-K reports for the 2006 fiscal year. The analysis enables companies to better understand how pension costs affect their overall cost structure, risk profile and competitive position.

"With increases in both asset values and discount rates, 2006 was the opposite of the so-called 'perfect storm' years of 2000-2002," said Steve Alpert, a principal and consulting actuary with Mercer. "The resulting improvement in funded status had a number of related positive effects, including improved sponsor cash flow and smaller than expected reductions in shareholder equity due to FAS 158."

FAS 158, the new accounting standard published in September 2007, requires plan sponsors to recognize in the balance sheet the net difference between plan assets and benefit obligations for both pension and other postretirement benefit plans. The inclusion in the balance sheet of previously off-balance-sheet unfunded benefit obligations was expected to have a significant adverse effect on shareholder equity; however, the improvement in plan funded status resulted in considerably smaller effects than predicted.

Plan sponsor cash flow was also improved, as plan sponsors only needed to make contributions for the value benefits earned during the year, and no longer had to make substantial additional contributions to close the funding gap.

Factors that have helped close the funding gap

Better than expected asset returns in 2006 helped close the gap between plan assets and liabilities, thereby improving plan funded status. For the fourth year in a row, plan asset returns met or exceeded expectations. The median return for 2006 was 13.4% compared to an expected return of 8.2%.

Asset returns were driven primarily by the substantial proportion of pension assets that continue to be invested in equity issues - on average, 63% of pension fund assets were invested in stocks at year-end 2006. Although plan sponsors are beginning to explore other investments - such as long duration bonds that mimic the changes in value of pension liabilities caused by discount rate changes, "the strong equity returns of the past four years may have erased the painful memories of the 'perfect storm' years of extreme funded status erosion," noted Bob Aglira, head of Mercer's Financial Strategy Group. The stock market in 2007 once again reminds us how risky equity investing can be: at its high point in mid-July, the S&P 500 was up more than 9% for the year but has given back more than half those gains in the last two weeks.

The improvement in funded status was also linked to an increase in the discount rate used for the calculation of the present value of liabilities to be paid in future years (an increase in the discount rate decreases the value of pension liabilities).

Plan sponsors re-thinking many aspects of pension plan programs

Plan sponsors are re-thinking many aspects of their pension plan programs. It remains to be seen what impact the Pension Protection Act (PPA) and mark-to-market accounting rules will have on plan sponsors' asset allocation and design decisions. Outside the US, where mark-to-market accounting rules have been in effect for some time, plan sponsors have reduced, but not completely moved away from, equity exposure. At the same time, the PPA offers some interesting new opportunities for pension plan design, such as leveling the playing field between 401(k) and cash balance plans and enabling automatic savings features in defined contribution plans.

About the study

Mercer based its analysis primarily on information contained in the 10-K reports filed by 484 of the companies in the S&P 500 for the 2006 fiscal year. The study provides benchmarking data against which pension plan sponsors can compare their plans' performance. Among these 484 companies, 367 reported information on defined benefit plan liabilities. The survey also collected data on defined contribution and retiree medical and life insurance plans.