Health of Defined Benefit Pension Plans at S&P 500 Companies Improves During 2007 for Second Straight Year, Mercer Reports

Business Wire, June 11, 2008

* Strong asset returns and an increase in discount rates helped to improve the 2007 median funded status to 94 percent, up from 89 percent in 2006.

* New pension funding rules required by the Pension Protection Act of 2006 are not expected to have a significant effect on most companies.

* Capital markets and the economic environment of 2008 remain volatile; many pension plan sponsors have significant exposure to equity markets and interest rate risk. No clear trend has yet emerged on the implications for year-end funded status.

NEW YORK -- In 2007, the financial health of pension plans at the largest US companies improved for the second straight year, with aggregate pension assets exceeding aggregate pension liabilities for the first time since the end of 2001, according to a new analysis by Mercer.

Aggregate pension plan assets of $1.56 trillion exceeded aggregate pension liabilities of $1.50 trillion in 2007 for the first time since year-end 2001, when aggregate pension plan assets of $951 billion backed pension obligations valued at $929 billion.

The funded status of pension plans sponsored by companies in the S&P 500 improved due to net asset returns generally exceeding expected 2007 targets, along with a 30 to 50 basis point increase in the discount rates used to value the actuarial pension liabilities. This combination helped to improve the median funded status for individual pension plan sponsors in the S&P 500 to 94 percent at fiscal year-end 2007, up from 89 percent at the end of 2006.

In the report, How does your retirement program stack up? - 2008 (www.mercer.com/retirementbenchmarking), Mercer analyzes retirement program data disclosed by the S&P 500 companies in their 10-K reports for 2007. The analysis enables companies to better understand how pension costs affect their overall cost structure, risk profile and competitive position.

"Retirement programs - including traditional defined benefit pension plans - are an important, and integral, part of a company's financials as well as a key human resource strategy, but they operate in a changing landscape," said Steve Alpert, a principal and consulting actuary with Mercer and primary author of the study. "This year, plan sponsors are preparing for the 2008 start-up of new funding rules under the Pension Protection Act, and assessing and managing the effects of accounting changes required by FAS 158. Many will be looking at their pension and post-retirement plans from a financial risk perspective - and taking an integrated approach to managing those risks."

Closing the funding gap

The overall improvement in funding status - as reported on companies' balance sheets - carried over to Mercer's estimate of the new funding target required by the Pension Protection Act of 2006 (PPA). At the median, the new funding target is estimated to be more than 100 percent funded, which means that many pension sponsors will not be required to contribute in 2008 any more than the value of benefits earned during the year.

Plan sponsors continue to take investment and interest rate risk with their pension portfolios, and most still have more than 60 percent of pension assets invested in equities. These sponsors were rewarded with actual asset returns during FY 2007 of 9.6 percent, outpacing both the expected asset return assumption (8.25 percent) and the liability return (3.3 percent) at the median. Asset returns for 2007 were not as strong as actual 2006 asset returns, which were 13.3 percent at the median, but funded status nevertheless improved significantly, largely due to the increase in the discount rate used to calculate the liabilities.

"Plan sponsors that invest in equities are betting that expected superior returns of these investments will offset the growth in plan liabilities. However, they may find that the risks of doing so outweigh the rewards - either because the risk to funded status is too large relative to other business risks, or the plan is funded well enough that outperformance may result in unproductive or trapped surplus that the company can't use," said Richard McEvoy, a principal in Mercer's Financial Strategy Group.

Outlook for 2008

"As we move forward in 2008, the capital markets and the economic environment remain volatile," Mr. McEvoy added. "With equities generally falling in value and discount rates rising, projected year-end pension funded status is difficult to predict at this point. With mark-to-market valuation now required for both funding and balance sheet recognition, the calculus for deciding on the mix and level of defined benefit and defined contribution benefits is changing."

About the study

Mercer based its analysis primarily on information contained in the 10-K reports filed by the companies in the S&P 500 for the 2007 fiscal year. The study, which has been widely quoted and published annually since 2003, provides benchmarking data against which pension plan sponsors can compare their plans' performance. Among these companies, 377 reported information on defined benefit pension plan liabilities. The survey also collected data on defined contribution and retiree medical and life insurance plans.