2014 was another case of "two steps forward, one step back" for pension funded status

Russell Investments' latest LDI update confirms what most pension plan sponsors already know: 2014 was not a good year for pension funding. This follows on the heels of an okay 2012 and a good 2013; our representative open plan gained about 16 percentage points of funded status in 2012 and 2013, and lost six in 2014.

These updates now have a history going back seven years and the chart above—which is described in more detail in a recently-published practice note—tracks how the representative open plan’s funded status has been affected by changes in interest rates and investment returns over that full period. The representative closed plan—not shown here—followed a similar pattern except that the fluctuations were less pronounced in each direction.

We see that market conditions have been, overall, favorable since the sharp decline of 2008. The recovery in funded status has, however, been sporadic, following a pattern that can loosely be described as “two steps forward, one step back.” The gains of 2009 and 2010 were largely surrendered in 2011, and the gains of 2012 and 2013 were partially given back in 2014.

Although interest rates and investment returns are the biggest drivers of short-term variations, funded status is also affected by other factors. Most notably, to the extent that plan sponsor contributions exceed (or lag) the value of new benefit accruals, this leads directly to an improvement (or a decline) in funded status. The net effect of these factors over 2008-2014 was positive, boosting the representative plan’s funded status by around 10% over 2008-2014 (this effect is not shown in the chart above although it is built into the monthly updates through an annual rebasing of the starting position that is used.)

If the pattern of “two steps forward, one step back” is to repeat itself again, 2015 will need to be a step forward. That will be made more difficult by new mortality tables (which most corporations appear likely to adopt in either their 2014 or 2015 financial statements.) These could result in a one-off increase in liabilities of the order of 5% to 7% for most plans, and a corresponding drop in funded status.

In short, when we step back from the short term ups and downs in pension funding caused by interest rates and investment fluctuations, we see long term ups and downs caused by those same factors and also by the impact of contribution policies and demographic changes. Most pension plans were hit hard by the financial crisis of 2008; the recovery since then has been long, slow and episodic.