Remember the three-legged stool? For decades, benefits agents, brokers and retirement advisers used that simple metaphor to explain retirement savings.

One leg is Social Security, one leg employer-sponsored pension plans and the final leg retirement savings using tax-incentive defined contribution plans and ordinary personal savings programs. Together, the three legs were said to support a secure retirement.

The metaphor is still popular, but the latest retirement benefit research indicates that the stool has gone wobbly and at least one leg is weaker than ever before.

The problems of Social Security are well known and offset somewhat by changes in the base retirement age to older than 66, but the latest problem involves corporate pension benefits.

Pension plans, notably the defined benefit pension plans that were common in the 1970s and 1980s, continue to be underfunded. And despite last year’s investment gains, funding hasn’t improved.

As a result, employers will be making changes in pension funding and distribution strategies, so retirement benefit experts probably need a new way to talk about retirement planning—and plan sponsors need a stronger message about retirement savings.

In November, the Pension Benefit Guaranty Corporation, the government agency that insures defined benefit pension plans, released its 2014 annual report. Chronically underfunded, the agency monitors the funding status of single- and multi-employer plans and charges employers an annual premium to fund replacement of benefits for failed plans. The agency insures about 1,400 plans covering 10 million workers.

The agency’s financial status and its analysis of the plans it insures are an important indicator of pension plan health, but the agency’s delayed reporting schedule can sometimes give an outdated financial reading. The November study noted that the agency’s deficit total increased to $62 billion last year.

The deficit was largely the result of the declining use of multi-employer pension plans, the collectively bargained retirement plans that provide benefits to union members employed by multiple employers in a specific industry or area. The multi-employer portion of the deficit increased to $42.4 billion from $8.3 billion in 2013, based on predictions that several large union plans are expected to become insolvent in the coming year.

Single-employer pension plans were in better shape, according to the PBGC. The portion of the deficit resulting from single-employer pensions improved to $19.3 billion, down from $27.4 billion the previous year. The agency presently insures 22,000 single-employer plans covering 31 million workers and retirees.

The agency advises that a stronger economy and better investment market returns buoyed the financial health of single-employer plans, making them less likely to need PBGC insurance.

As noted earlier, while the PBGC report is considered to be some of the best official information on pensions, it is not always current. More recent consulting firm reports indicate that the brief uptick in pension security was over almost before it began. And the investment returns that were supposed to transform pension security never quite materialized.

A pension funding report compiled by the consulting firm of Towers Watson and released in early January tells a different story. The pension funding status of the nation’s largest corporate sponsors actually reversed course and lost ground last year—after the brief uptick in funding levels.

The consultants reviewed plan data for 411 of the Fortune 1000 companies that sponsor tax-qualified pension plans. The results indicated that, contrary to the PBGC report, aggregate pension funding status got worse, declining to about 80% from 89% in 2013.

The analysis also found that the pension deficit increased to $343 billion, more than twice the deficit in 2013.
Why the discrepancy in financial indicators? Alan Glickstein, a senior retirement analyst at Towers Watson, writes that technical issues, including changes in mortality tables and interest rate assumptions, erased the investment market improvements. For pension funding, debt instruments were a better fit than the skyrocketing equities.

“Despite a rising stock market in 2014, funding levels for employer-sponsored pension plans dropped back to what we experienced just after the financial crisis,” he said. “A one-time strengthening of mortality assumptions alone is responsible for about 40% of the increased deficit.

“We also found that plan sponsors that used liability-driven investing strategies in 2014 had better results, as the declining discount rates were matched with very strong returns for long corporate and Treasury bonds.”

Pension plan assets increased by only an estimated 3% in 2014, from $1.36 trillion at the end of 2013 to $1.4 trillion at the end of 2014, reflecting an underlying investment return of about 9%—not quite the level of the major market indicators.

The returns actually varied by type of assets with large cap equities up about 14% and international equities declining about 5%.

Employers also contributed less to their plans. In 2014 plan sponsors contributed about $30 billion, 29% less than 2013 and the lowest level since 2008.

“Last year’s results surrendered most of the funded status gains earned in 2013,” noted Dave Suchsland, another senior retirement consultant. “This year will most likely bring higher expense charges, and unless there is an uptick in interest rates or equity market performance, eventually additional contribution requirements.”

Another analysis from consulting company Mercer confirms that the trends and technical changes of 2014 wiped out any gains that accrued in 2013. While the numbers are not exactly comparable to the Towers Watson study, they underscore the same trends.

Mercer analyzed the status of Standard & Poor’s 1,500 pension plans and determined that deficits more than doubled from $237 billion in 2013 to $504 billion at the end of 2014.

Interest rates were part of the problem. The rates declined 88 basis points from 2013, reaching their lowest levels in 2014, offsetting an 11.4% gain in the S&P 500.

The result, according to the Mercer study, was a drop in aggregate pension funding from 88% in 2013 to 79% last year.

“The gains of 2013 effectively disappeared in 2014 due to declining interest rates and improved mortality estimates despite the good year in domestic equities,” said Jim Ritchie, a principal in the company’s retirement practice.

He recommends that employers refine their funding and investment strategy to better manage pension risk. This strategy includes locking in any improvements in funding generated by short-term investment returns with long-term bonds.

The consultant also recommends that employers transfer some of their risk with cashout programs for former employees and annuity programs for targeted groups of employees.

For benefit agents and brokers, these trends present a series of new challenges. Employers will need more guidance in designing a package of retirement benefits. Whether or not employers sponsor defined benefit pension plans, their employees will continue to have retirement needs that are no longer met by the three-legged stool.

The author
Len Strazewski has been covering employee benefits issues for more than 30 years. He has an M.S. in Industrial Relations from Loyola University in Chicago.