Retirement Financial Management (RFM) Benchmarking
 

Mercer has completed its annual survey of retirement programs sponsored by companies in the S&P 500, using information primarily reported in 10-K filings for fiscal years ending in 2006. This survey tracks and measures important retirement benchmarks to help employers evaluate their retirement programs against those in the

entire S&P 500, or an industry group within it. Using the RFM Charting tool, survey results can be produced for just the utility industry.

A review of the utility industry benchmarks and statistics will touch on all three of the policy levers in Mercer’s Integrated Retirement Financial Management (iRFM) framework – investment, contribution and design.

Pension Plan Funded Status Improves

The financial health of utility pension plans improved significantly during 2006. Pension plan health, as measured by a plan’s funded status, improved mostly due to strong asset returns and a rise in discount rates. The median utility industry PBO funded status improved from 88 percent in 2005 to 93 percent in 2006. These funded status measures are slightly higher than the entire S&P 500, which improved from 81 percent to 89 percent.

Asset Returns Exceed Expectations

Better-than-expected asset returns helped to close the gap between plan assets and liabilities, thereby improving funded status. The median actual asset returns of 12.9 percent in 2006 exceeded the median expectation of 8.5 percent. Approximately 90 percent of utility plans exceeded expectations in 2006. Utility plan asset returns have met (2005) or exceeded (2003 – 2004, 2006) expectations over the past four years. The median asset return for the S&P 500 was slightly higher in 2006 and slightly lower in 2005 compared to the utility industry.

Liability Growth

Plan asset returns do not entirely account for the change in a plan’s funded status. The change in plan liabilities must also be considered. We define liability “return” as the net percentage increase or decrease in plan liabilities after adjusting for benefit accruals, benefit payments, and any plan amendments or curtailments. The median rate of return on utility plan liabilities during 2006 was 3.7 percent, significantly less than the 2005 median of 10.3 percent. The median utility plan discount rate increased from 5.6 percent in 2005 to 5.87 percent in 2006. These discount rates are 0.10 percent higher than the median for the entire S&P 500. Demographic gains/losses and other assumptions changes also contribute to the liability return.

Investment Policy

The allocation to equities of utility plans remained constant in 2006 at 65 percent, the same as the past four years. The equity allocation for the entire S&P 500 has gradually decreased from 65 percent to 63 percent over the past couple of years. The “other” category has been modestly increasing, indicating a slow shift to alternative assets such as private equity, timberland, infrastructure and hedge funds. It appears that while plan sponsors are concerned about the investment return volatility associated with equity exposure, the majority have not chosen to reduce their equity allocations.

Funding Policy

Plan sponsor contributions are another important component of the increase in funded status, particularly contributions over and above the value of benefits earned during the year. However, in 2006, it appears that many companies have funded their legacy costs, as contributions were closer to (or even less than) the cost of new benefit accruals. For utility plans, the median level of contributions less service cost as a percent of PBO decreased from 0.48 percent in 2005 to -1.16 percent in 2006. The entire S&P 500 saw a similar decrease from 1.59 percent in 2005 to 0.42 percent in 2006. The median utility plan was 105 percent funded on an ABO basis, whereas the entire S&P 500 was 98 percent funded on an ABO basis.

Design Policy

Utility industry plan sponsors continue to spend more money on total retirement benefit accruals compared to the entire S&P 500. When we examine the total “operational” for pensions, defined contribution and retiree medical plans, the median utility plan sponsor spends 1.12 percent of revenue versus only 0.83 percent for the S&P 500. The utility industry percentage has been stable for the past four years, while the S&P 500 percentage showed a steady decrease in 2003 – 2005, followed by stability. Operational expense includes service cost for pension and retiree medical plans and contributions for defined contribution plans. Utility industry operational cost for pension plans (0.71 percent versus 0.48 percent) and retiree medical plans (0.17 percent versus 0.05 percent) is higher than the S&P 500. However, the operational cost for defined contribution plans (0.24 percent versus 0.36 percent) for utilities is lower than the S&P 500. Operational cost excludes any legacy cost components, which were 0.26 percent for utilities and 0.14 percent for the S&P 500 in 2006.

Impact of FAS 158 on Shareholder’s Equity

With the implementation of FAS 158, all pension and retiree medical plan sponsors will recognize the funded status of these plans on the balance sheet through the Accumulated Other Comprehensive Income account. Previously, this only applied to under-funded pension plans. In 2006, the after-tax impact of FAS 158, measured as the after-tax reduction in shareholder’s equity, was slightly lower for utilities (1.2 percent) versus the entire S&P 500 (1.7 percent). However, measuring the same FAS 158 impact in 2006 as a percentage of market capitalization showed that utilities were impacted more than the S&P 500 (1.0 percent versus 0.4 percent).

Summary

2006 was a year of significant change for DB plan sponsors – the Pension Protection Act and FAS 158 combined to cause plan sponsors to rethink many aspects of their retirement programs. Plan sponsors continued to re-evaluate their retirement programs during 2007 as the new regulations took effect, bringing a significant shift toward more mark-to-market valuations for both funding and expense of these plans.