Strong November for Equities Yields Lower Pension Funding

Most gauges of U.S. corporate pension health remained fully funded in November, even as they dropped from higher levels earlier in the year, data showed.

The funding status of corporate pensions in the U.S. were down narrowly in November, as liability growth outweighed investment gains.

For the month of November, pension funding statuses declined by 1.4 percentage points from 105.5% to 104.1%, while assets increased by 5.1% and liabilities increased by 6.5%, according to Insight Investment. During the month, the average discount rate fell by 55 basis points to 5.05% in November from 5.61% in October. The change in rates is primarily due to the change in the risk-free rate, while spreads decreased considerably during the month.

For more stories like this, sign up for the CIO Alert newsletter. 

“Year-to-date funded status has still improved by more than 7%, driven primarily by pension discount rates having risen by ~200 bps over the year,” said Sweta Vaidya, head of solution design at Insight Investment. “The Fed has indicated that it will begin slowing down on rate hikes, but that we may expect rates and inflation to persist higher for longer than originally anticipated.”

LGIM America’s Pension Solutions Monitor, which estimates the health of a typical U.S. corporate defined benefit pension plan, estimates that pension funding ratios decreased from 100.7% to 100.2% through November.

Equity markets had a strong month, with global equities and the S&P 500 rising 7.8% and 5.6%, respectively. Plan discount rates were estimated to have decreased roughly 62 basis points over the month, while the Treasury component decreased 43 basis points and the credit component tightened 19 basis points.

Overall, plans with a traditional “60/40” asset allocation increased 6.1%, and liabilities rose by 6.7%.

According to October Three’s November monthly pension update, pension finances were mixed in November, as lower interest rates offset the impact of higher stock prices.

According to October Three’s data, interest rates, which have risen steadily all year, fell in November, pushing up bond returns. Treasury yields fell 0.4% last month, and corporate bond yields declined 0.5%. As a result, bonds gained 4% to 7% in November but remain down 13% to 24% for the year, with long-duration and corporate bonds performing worst. October Three expects most pension sponsors will use effective discount rates in the 5.0% to 5.2% range to measure pension liabilities at the end of 2022.

Corporate bond yields fell 0.5% during November but remain up 2.3% this year. As a result, pension liabilities rose 5% to 8% last month but are still down 16% to 27% for the year.

Stocks advanced strongly and broadly during November. A diversified stock portfolio gained 7% last month but is still down more than 15% in 2022. With one month to go, 2022 is looking like a surprisingly positive year for pension finances, particularly in view of double-digit stock market declines.

The Infrastructure Investment and Jobs Act provided additional relief for pension, expanding upon a pension funding relief law signed in March 2021.

“The new laws substantially relax funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors. However, the surge in interest rates this year, if sustained, will reduce or eliminate the impact of funding relief,” wrote Brian Donohue, a partner in October Three.

During the month, the Milliman 100 Pension Funding Index funded ratio declined from 113.3% in October to 111.2%. The drop was due to the monthly discount rate decreasing to 5.16% from 5.71%. As a result, the PFI projected benefit obligation rose to $1.342 trillion, representing a loss of $76 billion for the month, even as investment gains of 4.63% caused the market value of assets to rise by $59 billion.

“November’s discount rate decrease was the largest monthly drop of the year and only the second monthly decline we’ve seen in 2022,” said Zorast Wadia of Milliman, co-author of the PFI. “This caused the plans’ funded status to drop, despite November’s stellar investment returns, which were the largest monthly gain of the year.”

Wilshire’s U.S. Corporate Funded Status for the month of November found that the aggregate funded ratio for U.S. corporate pension plans was unchanged from October, ending the month at 99.1%.

The month’s activity in funded ratios resulted primarily from a 6.3% increase in liability values, offset by a 6.4% increase in asset values. The aggregate funded ratio is estimated to have increased by 2.9% year-to-date and 5.5% over the previous 12 months.

According to the WTW Pension Finance Watch, the equity portion of the benchmark portfolio returned 6.3% in November, with the international equity asset class having the largest growth. Yields on long high-quality corporate bond indices decreased an average of 56 basis points, and the yield reductions were followed by decreases in long Treasury rates. The yields on 10- and 30-year Treasury bonds decreased 42 basis points over the month.

The WTW Pension Index tracks the performance of a hypothetical pension plan invested in a portfolio with 60% invested in equityand 40% in fixed income. This portfolio recorded a 5.1% return for the month.

Pension obligations of the interest rates used for their valuation. The liability implicit in the index increased by 7.2% from the discount rate change and the accumulation of interest. These factors contributed to an overall decrease of 1.9% in the WTW Pension Index, which closes the month at 103.4%.

“Everything continues to be about interest rates,” proclaims Agilis’s U.S. pension briefing for November. “funded status at the end of the month will be close to where it started, despite the big changes in discount rates and investment returns.”

Agilis highlights that the Treasury yield curve continues to be inverted, a potential indicator of a looming recession. The lower discount rate meant higher liabilities for pensions; the combination of lower discount rates and the corresponding higher liabilities offset market gains, leaving pension plan funded ratios at, or slightly lower on the month.

Pension plan sponsors are still better off today than they were at the start of the year which could have a meaningful effect on year-end balance sheets into the end of 2022.

Here’s How Much Rising Rates Help Pension Plan Liabilities

U.S. Pension Funding Ratios Continue to Increase

Tags: Agilis, Insight Investment, Legal & General Retirement America (LGIMA), Milliman, October Three Consulting, Pension Funding Status, Pensions, Sweta Vaidya, WTW, Zorast Wadia

The Pennsylvania State Employees’ Retirement System reported a 5.04% loss for the third quarter and a 16.13% loss for the year through September 30, lowering the pension fund’s market value to $32.5 billion from $34.5 billion through the second quarter and $39.9 billion at the start of the year.

Despite the losses, the performance exceeded that of its benchmark portfolio, which lost 5.08% during the quarter and was down 16.39% year to date.

Emerging markets equity was PennSERS’ worst performing asset class for both the third quarter and the year to date as of September 30, tumbling 10.22% and 29.74%, respectively, during those periods. International developed markets equity lost 8.79% during the quarter and 26.78% through Q3, followed by private equity, which lost 5.86% during the quarter and was down 4.74% over the first nine months of the year.

The portfolio’s Treasury inflation-protected securities dropped 5.6% during the quarter, bringing its nine-month loss to 14.85%, while its U.S. equity investments declined 4.35% for the quarter as its total loss for the year grew to 24.51%. Real estate investments closed the quarter with a 1.59% loss but were up 4.56% year to date.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

Legacy private credit and cash were the only assets that did not decline during the quarter, rising 0.63% and 0.51%, respectively, and increasing 6.57% and 0.70%, respectively, during the first three quarters. All returns are reported net of fees, while private equity and real estate returns are reported on a quarter lag and are adjusted for cash flows.

PennSERS reported three- and five-year annualized returns of 4.89% and 5.09%, respectively, compared with its benchmark’s return of 5.40% and 5.89%, respectively, during the same time periods. Over the longer term, the pension fund reported investment returns of 6.53%, 4.28%, 7.53% and 6.53%, respectively over the past 10, 15, 20 and 25 years. The pension fund underperformed during each of those time periods, as its benchmark returned 7.20%, 5.58%, 8.32% and 6.99% respectively, over the past 10, 15, 20 and 25 years.

“SERS is a long-term investor with the mission of paying pension benefits for the lifetime of our members,” Joe Torta, the executive director of PennSERS, said in a statement. “Our members can be assured that the fund is fully invested and well-positioned to benefit as markets recover.”

The pension fund’s asset allocation, as of September 30, was 29.9% in U.S. equity, 21.1% in fixed income, 19.9% in private equity, 11.6% in international developed markets equity, 8.7% in real estate, 3.2% in emerging markets equity, 3.0% in inflation protection, 1.3% in cash, 1.2% in legacy private credit and 0.1% in legacy hedge funds. [Source]

The pension fund’s board also approved a $100 million investment in the Hellman & Friedman Capital Partners XI fund within its private equity asset class.