The outlook for funded pension plans is bleak as the economic downturn continues and new funding rules are applied. Although many of the losses are due to equity declines, equity allocation targets for 2009 have seen little change, finds a Watson Wyatt study.

Last year the aggregate funding for the 100 largest U.S. pension sponsors declined $303 billion, falling from an $86 billion surplus in 2007 to a $217 billion deficit at the close of 2008. In terms of percentage, the aggregate funding levels slipped to 30%, down from 109%.

“Plan sponsors were hit hard with a double whammy in 2008 with severe market declines and new funding rules coming into effect,” says David Speier, senior retirement consultant at Watson Wyatt. “This combination will require employers to make staggering pension contributions over the next couple of years, at a time when they can least afford them.”

Pension plan assets also declined by 26% in 2008, mostly due to significant equity losses. Those plans that had 20% of their portfolio in equities lost an average of 6%, whereas those with an equity allocation of 55% to 60% lost 24% of assets, and those with an allocation of 90% or more in equities lost 32% of assets.

Despite the fact that equity targets have not declined significantly, actual equity allocations were much lower at year-end. For the 83 companies that provided data on this subject, the average target equity for 2009 is 55%, down from 58% for 2008. However, due to a steep drop in the stock market, with bonds significantly outperforming equities, actual equity allocations fell to 48% at the end of 2008 from 59% in 2007. It is unclear whether plans will redress this imbalance.

“Many pension plan sponsors have remained committed to equity investments as they have been expected to provide the best long-term returns,” said Carl Hess, global head of investment consulting at Watson Wyatt.

“However, the recent financial turmoil shows that large equity positions can create substantial risks. Companies can alleviate some of this risk by adopting liability-driven investment strategies, which utilize bond and derivative markets to help companies better hedge their long-term pension liabilities, while at the same time making sure the overall risk level in their portfolio is at a level they can live with,” explains Hess.

Meanwhile, the latest update to the Milliman 100 Pension Funding Index shows that the funded status of pensions fell $33 billion in February. The DB plans surveyed lost $54 billion in assets, which was offset by liability decreases of roughly $21 billion. In the last year alone, the funding ratio for these pensions has fallen from 99.6% to 71.7%, Milliman reports.

“January was a terrible month for asset values, and February was worse,” said John Ehrhardt, co-author of the Milliman 100 Pension Funding Index. “We’re not even through the first quarter yet, and already funding status had declined from 77.2% to 71.7%, and that’s with asset values being offset by changes in discount rates.”

Milliman finds that funding status has fallen by $337 billion in the last 12 months, thanks in large part to a -26% asset return. As of the end of February, the total asset value for these pensions stood at $869 billion.

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