Corporate Pension Plan Funded Status Shows Continued Improvement

The financial health of U.S. corporate pension funds experienced a marked improvement in May, continuing a positive trend seen over the past five months, according to a round-up of the country’s pension watchers.

The main reasons for the positive funding trends last month across various corporate defined benefit plans included positive economic indicators, strategic investment approaches such as cash-flow-driven strategies and resilience in market performance despite lower interest rates.

“May’s improvement is the fifth month in a row of funded ratio improvement,” says Zorast Wadia, principal and consulting actuary at Milliman.

This month’s strength of funding ratios, Wadia noted, was driven by equity markets that were strong enough to counter a decline in discount rates, which dropped about 13 basis points to 5.53% from 5.68% on average. That was a turn from April, when discount rates increased by 44 basis points, helping to create that month’s funded status boost.

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“May’s improvement was very different as April was a very poor return month,” Wadia says. “That was the worst return month of the year. January, February and March were generally stable or positive return months.”

Similar to those earlier months, Wadia says May’s assets increased more than liabilities. As a result, there was a $4 billion pickup in the funded status, he says, representing a percentage change to 103.4% from from 103.1%.

“So again, we’re still in surplus territory and there continues to be an improvement,” he says.

Positive Funded Status

October Three reported similar positive trends, with higher stock markets counterbalancing the impact of lower interest rates.

The actuarial service provider’s analysis of two model plans revealed that Plan A, a traditional plan with a 60/40 asset allocation, saw a significant improvement of over 1% in May, culminating in an 8% increase for the year.

The Plan B portfolio, which is more focused on retirees and emphasizes corporate and long-duration bonds, recorded a modest gain, bringing its year-to-date improvement to nearly 2%.

LGIM America’s Pension Solutions Monitor also documented an increase in pension funding ratios, rising to 108.8% from 107.6% over the month. The firm attributed the increase to strong performances in equity markets, with global equities rising by 4.1% and the S&P 500 by 4.8%.

The average discount rate decreased by 20 basis points, largely due to a reduction in the Treasury rates. These factors contributed to a 3.5% increase in plan assets, surpassing the 2.3% rise in liabilities and leading to an overall improvement in funding ratios, according to LGIM.

Wilshire’s analysis indicated just a slight increase in the aggregate funded ratio for U.S. corporate pension plans, rising by 40 basis points to 100.6% by the end of May. This increase was driven by a 2.6% rise in asset values, which more than offset a 2.2% increase in liabilities. Despite the drop in corporate bond yields increasing the liability value, the positive returns from most asset classes contributed to the improved funded ratio.

Strong Economics

Michael Clark, chief commercial officer at Agilis, agreed that May was a positive month for pension plans, buoyed by positive economic indicators and strong market performance.

“Even though discount rates were down on the month, the corresponding increase in liabilities was generally not enough to bring funded status down,” says Clark. “We keep beating the drum that plan sponsors need to take a serious look at how well they are hedged against interest rates, and we haven’t changed our tune.”

WTW reported that its Pension Index reached its highest level since late 2000, reflecting a 0.5% increase in May. This improvement was driven by strong investment returns, particularly in the equity portion of the benchmark portfolio, which saw a 4.6% return. For WTW, fixed-income investments also performed well, with long Treasury bonds and long corporate bonds leading the gains.

Adding to the optimistic outlook, Adam Turnquist, chief technical strategist for LPL Financial, provided a broader market perspective. He noted that the S&P 500’s 4.8% rise in May contradicted the traditional “Sell in May and Go Away” strategy, suggesting that the adage might be less relevant in today’s markets.

Turnquist highlighted that April’s losses were more than offset by May’s gains, underscoring a robust market rebound that bodes well for the future performance of pension plan assets.

Finally, Insight Investment highlighted a 1.1% increase in funded status, moving to 114.6% in May from 113.5% in April. This gain was, again, primarily driven by equity outperformance despite a modest decline in Treasury rates.

“At prevailing funded status levels, more certain approaches to meeting benefit obligations can be implemented,” said Ciaran Carr, head of client solutions group in North America at Insight Investment. “Cash-flow-driven investment strategies seek to incrementally improve the surplus position with a lower likelihood of incurring future funded status deficits.”

Tags: Adam Turnquist, Agilis, Ciaran Carr, Corporate pension funding, Insight Investment, LGIM America’s Pension Solutions Monitor, LPL Financial, Michael Clark, Milliman, October Three Consulting, WTW Pension Index, Zorast Wadia

The Federal Reserve is shrinking its balance sheet, which it had pumped up during the 2008-09 financial crisis and then amid the height of the pandemic in 2020, as it sought to stabilize the bond market and plug cash into the U.S. economy. Now the central bank might change its reduction strategy—and that could impede plans to lower interest rates, per research from asset manager BlackRock Inc.

This question comes as the Fed mulls over whether to cut its short-term benchmark rate, to forestall an economic downturn. Continued reduction in Fed bond holdings could hinder such an effort if long-dated bonds, now largely kept on the books, were ditched, as well.

Some history: By buying Treasury bonds and mortgage-backed securities, the Fed expanded its holdings to a peak of almost $9 trillion in mid-2022, from $0.9 trillion at the end of 2007 and $4 trillion at the start of 2020. Since then, mainly through letting some fixed-income securities mature, it dipped to $7.2 trillion last month.

The Fed has not indicated when it will end the runoff or at what level. “The Federal Reserve’s balance sheet is one of the world’s most important security portfolios, yet its ongoing importance for markets and financial conditions is often underappreciated.” declared the BlackRock study, titled “QT-Lite: Quantitative tightening’s limited impact.”

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A little-known fact is that the Fed has disposed of more short-term securities and let more long-dated bonds remain, an allocation that exerts “a powerful downward force on bond yields,” according to the study, led by Tom Becker, portfolio manager on BlackRock’s global tactical asset allocation team. That is the equivalent of the Fed’s dropping rates two percentage points, below the present band of 5.25% to 5.5% for the fed funds rate, the report found.

Meanwhile, the Fed’s portfolio still contains more than 30% of all of outstanding long-term Treasurys, meaning with terms of 10 years or longer, the BlackRock paper reported, “thereby removing a significant amount of the supply of long-dated government securities and creating scarcity.”

The relative scarcity has helped push up long-term bond prices and thus pull down their yields. The 10-year’s yield fell to 4.4% on Monday from 5% in October 2023. (To be sure, other factors are involved with the yield, such as ongoing high inflation, which can increase yields.)

The Fed has continued to reinvest the proceeds of some maturing bonds in excess of the monthly targets for expiration, mainly long-dated ones. In 2023, those rollovers totaled $860 billion, meaning that the Fed purchased nearly 10% of the new supply of 10- and 30-year bonds at Treasury auctions last year.

These actions, the BlackRock report noted, help “to explain the resilience of the economy to the policy tightening of 2022 and 2023, as well as continued inversion of the U.S. yield curve,” where low-maturity paper yields more than longer-dated issues.

But what if the Fed chose to let longer-dated bonds expire, or even sold them? That would remove downward pressure on long yields, which affects, among other things, home mortgage rates.

The BlackRock paper contended: “Though the likelihood of any policy changes happening this year are exceedingly low, we think the risks for a tightening from balance sheet changes could grow once we get through the U.S. elections in November.”