U.S. corporate pension funding ratios dipped slightly in September, as falling yields drove liabilities higher than could be offset by strong gains in equities, according to most of the country’s largest plan consultants.
The consensus of slight declines in pension funding status comes after a month in which the Federal Reserve cut interest rates for the first time since the COVID-19 pandemic and its campaign of hikes to combat inflation, which began in 2022. Pension liabilities, driven in part by market interest rates, rose 2% to 3% last month and are up for the year 3% to 5% through September, according to consultancy October Three.
Some of that liability pressure was offset by stock gains, according to the firm, which were up in September due mostly to large-cap U.S. stocks, particularly tech stocks. In total, however, the two model pension funding plans October Three tracks dropped by slightly less than 1% at month’s end.
Those declines do not offset a strong year for pension funding status, says Brian Donohue, a partner in the firm, and while short-term rates are likely to trend down, long-term rates are the more important area for defined benefit plans, he says.
“It’s that long end of the curve that is more meaningful,” Donohue says, noting that those rates rose relatively quickly in recent years, from about 3% to 5%, when the Federal Reserve rapidly hiked short-term rates to offset inflation.
While long-term rates should start declining in coming months, Donohue doesn’t see it going back to that 3% rate in part because he sees inflation being a bit sticky.
“Long-term rates may move lower, but I don’t see anything like the 3% or 3.5% some may be expecting,” he says.
The higher rates, mixed with relatively strong markets, have October Three’s Plan A model up 7% on the year despite dips; that plan is a traditional plan with a 60/40 asset allocation. Its Plan B, meanwhile, is up more than 1%; that model is a largely retired plan with a 20/80 allocation, with a greater emphasis on corporate and long-duration bonds.
2024 Pension Experience – Funded Ratio
Source: October Three Consulting
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Mercer, a business of Marsh McLennan, also reported a pension funding decline in September. The firm’s estimated aggregate funding level of pension plans fell 1 percentage point in September to 107%. Marsh attributed that drop to a decrease in discount rates, though the fall was partially offset by growth in equities.
“While long-term bond markets had already priced in much of the Fed’s September interest rate cut, we did see a slight decline in pension discount rates,” Matt McDaniel, a partner in Mercer’s wealth practice, said in a statement with the report. “Meanwhile, the bull run for equity markets continues and set new all-time highs yet again in the month.”
He also noted that while future Fed rate cuts may not directly lower pension discount rates, the uncertainty of both the timing and the extent of future rate cuts will cause funded status volatility. In recent weeks, a robust jobs report and a stronger-than-expected consumer price index number had market watchers pondering a more aggressive rate-cutting stance by the Fed.
“Many sponsors have built up surpluses within their plans and should be considering what de-risking methods make the most sense for their particular situation,” McDaniel said.
Benefits consultancy Milliman’s Pension Funding Index, which tracks the largest 100 U.S. corporate pension plans, also reported a slight decline in September to 102.4% at month-end from 102.6% at the end of August. Here again, plan assets increased due to a 1.74% average investment gain, but the discount rate declined by 0.14% to 4.96%, creating liabilities that “eclipsed” asset growth, “leading to a $12 billion loss in funded surplus,” according to its report.
MetLife Investment Management reported a funded status decrease for all of the third quarter. For September, the asset management business of MetLife Inc. estimated that funding status dropped to 104.0%, down 1.6 percentage points from the end of Q2.
“Pension liabilities increased due to falling interest rates,” the firm wrote in its report. “Discount rates fell by 50 basis points with a decrease of 55 basis points in interest rates and spread tightening of five basis points. Changes in the discount yield curve accounted for 10 basis points of widening.”
MetLife also noted that, over the past 10 years, pension funded status dropped to its lowest level on June 27, 2016, at 74.7%, and peaked on May 28, 2024 at 106.3%.
Bright Spots
Two pension consultancies did find slightly rosier results.
Agilis, in its U.S. Pension Briefing, noted that the Fed’s first interest rate cut since the COVID-19 pandemic led to falling yields, particularly for shorter-duration bonds, and contributed to an increase in pension liabilities of between 1 and 2 percentage points.
However, the firm concluded that “the strong investment returns across nearly all sectors helped offset these increases.” That environment, according to Agilis, led to pension plan sponsors likely seeing “slight improvement to their funded status, contingent on their asset allocation and initial funding levels.”
Fund tracking from Aon and Wilshire, which both consider defined benefit plans from companies in the S&P 500 Index, reported slight improvement in funding status. Aon found an increase of just 0.1 percentage point, boosting its measure to 100.8% from 100.7%; Wilshire, meanwhile, reported a somewhat more improved status. That firm found a 0.3-percentage-point boost to 101.6% from 101.3%.
Whatever October brings, prognosticators are forecasting more pension funds will be offloading their liabilities into 2025. In plan sponsor polling released this week, MetLife found that 93% of companies with de-risking goals plan to completely divest their defined benefit pension plan liabilities, up from 89% in last year’s poll.
Donohue of October Three says that, as interest rates are slated to keep coming down, owning bonds is becoming more attractive again, even as funding ratios begin to dip. That, in turn, means further impetus for some firms to consider pension risk transfers to offload some or all pension obligations.
Tags: Agilis, Brian Donohue, Defined benefit (db) pension plans, Matt McDaniel, Mercer, MetLife Investment Management, Milliman Pension Funding Index, October Three Consulting, Pension Funding Status
