Pension plans for the largest U.S. companies are at their healthiest in over a decade, according to financial services firm Aon (NYSE:AON). The average pension "funded ratio" for public companies in the S&P 500 stock index was 102% as of last Thursday, marking the highest level since at least the end of 2011 when the ratio stood at around 78%.
The funded ratio is a measure of a pension's financial health, comparing a company's pension assets against its liabilities. Essentially, it assesses the money a pension currently has on hand versus the funds a company needs to pay future pension income to workers.
"This is a really good thing," Byron Beebe, global chief commercial officer for Aon, said on Monday. "It's at the highest it's been in a really long time." However, as the American Academy of Actuaries points out, pension funding is merely a "financial snapshot ... at a single moment," and can change based on factors like the health of the U.S. economy.
This improvement in pension funding is significant for workers. A better funded status makes it more likely companies will keep their pensions active and reduces the risk of benefit cuts for some workers. In extreme cases, underfunding can lead to benefit cuts. Companies with failed pensions may transfer their obligations to the federal Pension Benefit Guaranty Corp., which guarantees pension benefits up to a limit, based on age.
Pensions in the private sector have become rarer over the decades as companies have replaced them with 401(k)-type plans. Defined-benefit plans peaked in 1983 with 175,000 plans in the private sector, but by 2020 that number had declined to about 46,000, according to U.S. Department of Labor data. Many of these plans are now "frozen" and no longer allow workers to accrue benefits.
The recent improvement in pension funding is largely attributable to three factors: a rise in interest rates, strong stock performance, and policy changes to how some companies fund their plans, according to John Lowell, partner at October Three, a pension consulting firm. Higher interest rates on bonds generally mean companies don't have to contribute as much money to their pensions today to satisfy future benefits. Furthermore, companies have become more proactive about making contributions to their plans to ensure they're fully funded due to rising insurance premiums paid to the PBGC.
Companies have also adopted investment strategies that fluctuate less with the whims of the investment markets, said Beebe at Aon. For a portion of the portfolio, they buy bonds whose income matches that of future pension promises, offering more predictability.
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