A month of strong investment returns, partially offset by a small increase in liabilities as a result of modest decreases in discount rates, has once again been good news for the funded status of U.S. corporate pension funds.
As stock markets surged in the first half of 2023 and interest rates held steady at 5% or higher, many pension funds are nearing, or have reached, fully funded status. In June, the WTW Pension Index attained the highest level it has seen in more than two decades.
The WTW Pension Index tracks the performance of a hypothetical pension plan invested in a 60% equity and 40% fixed-income portfolio. The portfolio recorded a 3.8% return for the month, and liabilities increased by 0.9% due to the discount rate change and the accumulation of interest.
These factors contributed to an overall increase of 2.9% in the WTW Pension Index, which closed the month at 105.5% funded status.
Rate Hikes Still Possible
The Federal Reserve’s latest forecast suggested that at least two more interest rate hikes are possible this year in the central bank’s effort to quell inflationary pressures. However, according to the latest data from the Bureau of Labor Statistics, consumer prices rose at the slowest pace (0.2% in June) since March 2021, a sign that inflation is cooling down.
But policymakers still hope to lower inflation down to 2%, which could mean more rate hikes. Royce Kosoff, managing director of retirement at WTW, says rate hikes would help a plan sponsor from a liability perspective, but they would also diminish fixed-income returns.
“The message to plan sponsors is just to continue to monitor [the market],” Kosoff says. “Monitor your funding policy, monitor the assumptions that you use and monitor your investment strategy, as well.”
Insight Investment found that funded status improved by 2.2% last month—increasing to 105% in June from 102.8% in May. Sweta Vaidya, head of North American solution design at Insight Investment, said this increase was driven by strong equity returns, which improved asset levels, while liabilities were fairly stable due to discount rates being flat during the month.
“Earlier in June, the Fed held rates steady for the first time since the hiking program began in March 2022,” Vaidya said in a written statement. “However, we have been told to expect more rate hikes to control inflation, which may take at least another year or two to bring down to target levels. The market appears divided on whether a recession is likely in the interim, which should incentivize pension investors to reduce the uncertainties that they can, in order to leave room for those they cannot predict.”
According to Insight Investment’s model, assets returned 2.5% in June, and liability growth was 0.4%. The average discount rate increased by one basis point to 5.09% from 5.08%, the firm found.
Returns Drive Funded Status
October Three Consulting also found that stocks gained ground across the board during June, with all indexes ending the first half of 2023 with solid gains. Interest rates inched higher in June, and as a result, bonds lost a fraction of 1% last month. In the model plans that October Three tracked in June, Plan A, with a 60/40 asset allocation, gained 3%, and Plan B, with a 20/80 allocation, gained 1%.
As discount rates edged higher, October Three expects most pension sponsors will use effective discount rates in the 5.0% to 5.2% range to measure pension liabilities right now.
The Milliman 100 Pension Funding Index funding ratio rose to 102.2%, as of June 30, from 100.7% at the end of May. Monthly investment returns of 1.76% largely drove this result, boosting the market value of plan assets by $17 billion, to $1.346 trillion by the end of June for the 100 plans the company tracks.
A slight rise in discount rates also contributed to the funded status improvement, according to Milliman. As rates rose to 5.20% in June, the PFI plans’ projected benefit obligation declined to $1.316 trillion from $1.320 trillion over the period.
Looking forward, under an optimistic forecast with rising interest rates (reaching 5.50% by the end of 2023 and 6.10% by the end of 2024) and asset gains (9.8% annual returns), the funded ratio would climb to 108% by the end of 2023 and 122% by the end of 2024, according to Milliman. Under a pessimistic forecast (4.90% discount rate at the end of 2023 and 4.30% by the end of 2024 and 1.8% annual returns), the funded ratio would decline to 98% by the end of 2023 and 89% by the end of 2024.
Record Results
Wilshire found that the aggregate funded ratio for U.S. corporate pension plans increased by an estimated 2.3% month-over-month, ending June at 103.5%. The firm stated that the change resulted from an increase in asset value and no material change in liability value.
“June’s funded status saw the largest monthly increase since October 2022 due to asset value increases, with the performance of the FT Wilshire 5000 in the first six months of this year the strongest it has been since 2019, and the 11th strongest since the inception in 1974,” stated Ned McGuire, managing director at Wilshire. “With June’s month-end funded ratio estimate of 103.5%, U.S. corporate pension plans are fully funded in aggregate, and at [their] highest level since year-end 2007, which was estimated at 107.8%, before the Great Financial Crisis.”
LGIM America’s June Pension Solutions Monitor similarly estimated that the average corporate pension funding ratio increased to 103.5% in June from 100.7% in May. Plan assets with a traditional “50/50” asset allocation increased 3.3%, while liabilities increased by 0.5%, resulting in a strong improvement in funding ratios by the end of June, according to LGIM.
Because of June’s strong equity performance, Agilis stated that funded status most likely improved for plans with asset allocations to equities, compared to those that are more liability-driven.
“The Treasury yield curve increased during the month on news that the Federal Reserve would likely raise the Federal Funds Rate at least two more times this year, even though they didn’t raise the rate in their June 2023 meeting,” an Agilis report stated. “At the same time, economic data in June continued to show positive signs, causing a narrowing of credit spreads. The combination of these two factors resulted in a slight decrease in pension discount rates over the month, increasing liabilities anywhere from 0.5% to 1.0% depending on duration.”
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Tags: Agilis, Corporate pension funding, Insight Investment, Interest Rates, LGIM America’s Pension Solutions Monitor, Milliman 100 Pension Funding Index, October Three Consulting, Royce Kosoff, Sweta Vaidya, Wilshire, WTW Pension Fund Index