Surging Stocks Improve Pension Funding Levels, But De-Risking Isn’t at Risk

A strong stock market delivered the goods and then some for pension funding levels, both public and corporate, in the first quarter. But don’t expect companies to pull back from their campaign to shift into safer (if low-paying) bonds from stocks.

That’s the conclusion from JPMorgan’s global market strategy team, which noted in a report that this development didn’t mean that corporate plans would ease up on their de-risking—that is, moving into bonds from stocks. Reason: Company defined benefit (DB) plans already are almost fully funded, so why bother grabbing alpha from equities?

In fact, corporate fund chiefs are best advised to lock in their comfortable positions by continuing the de-risking campaign, wrote Morgan’s team, headed by Nikolaos Panigirtzoglou. His report contended that “the bigger the funding position and the closer pension funds are to fully funded status, the higher the incentive to de-risk.” So the liability-driven investing (LDI) movement, the embodiment of the de-risking trend, will keep on keeping on.

After all, few expect any major gyrations from the fixed-income market. Federal Reserve Chair Jerome Powell has signaled that near-zero short-term interest rates will prevail for at least the next couple of years. And the run-up in longer-maturity bonds seems to have reached a ceiling.

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Corporate plan funded levels surged to 98.4% in the recent March-ending quarter, up from 82.3% last July, a study from the Milliman consulting firm of the top 100 DB plans in the first quarter indicated. Last summer, the 10-year Treasury hit a low of 0.5% yield. And now it has jumped to 1.65%, although that is down from the recent peak of 1.75% a month ago.

And stocks? As of last July, the S&P 500 had climbed almost 40% from its March 2020 nadir. At last Friday’s close, the index has soared 81% from that dark time.

The Treasury action has given another leg up to these plans, JPM found: Their liabilities’ present value shrank $179 billion due to the higher 10-year yield. Future pension payments are discounted at that higher point, meaning the amount on hand today is lower to make those future payments.

Meanwhile, the 100 largest public plans also showed good gains, rising to 79% funded from 66% in last year’s initial quarter, Milliman data show. Just not as good as the corporate plans. Because the public ones’ funded status is so low, JPM figured, they have less incentive to de-risk, believing that their best chance to beef up their levels is via the stock market. “Their funded status is a lot worse than their private counterparts,” the JPM note read.

Making matters worse, there is a big disparity among the public plans. Funding was 90% or more for 31 retirement programs, between 60% and 90% for 47, and less than 60% for 22.

“Their equity allocation already is very high,” warned the JPM report, “and their bond allocation stands at a record low 20%.”

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Tags: 10-year Treasury yield, Alpha, De-Risking, Federal Reserve, Interest Rates, Jerome Powell, liability driven investing, Milliman, present value, Stock Market

Defined contribution (DC) plan sponsors have a “clearer path” to offer in-plan guaranteed retirement income, thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act, according to a new report from PGIM.

The report said that with the SECURE Act including a provision that will require a lifetime income disclosure on participant statements by the end of this year, “we should see projected retirement income become a standard metric for participants in DC plans in the future.”

The SECURE Act comes with some important implications, according to the report, including a greater ability to protect workers against longevity and investment risks by making it easier for them to convert savings to guaranteed income in retirement.

More specifically, the act created a safe harbor that eases liability concerns that have often stood in the way of plan sponsors offering annuities within a DC plan.

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“It also brings more certainty and clarity to how a plan sponsor can satisfy its fiduciary duties when selecting an annuity provider, and offers efficiency and cost savings to the annuity provider selection process,” said the report, which includes results of a survey of more than 130 plan sponsors.

The report also said there could be an opportunity for sponsors to review their plan’s available distribution types. For example, systematic withdrawals allow participants to set up a process to automatically withdraw portions of their DC plan balance over time, rather than taking a single lump-sum distribution.

“This plan design feature is a great step in providing more distribution flexibility to retirees and may allow them to set up an automated retirement paycheck,” said the report, which added that less than 50% of plans with assets between $100 million and $1 billion allow systematic withdrawals, while about one-third of plans greater than $1 billion still don’t allow systematic withdrawals.

With more clarity and protections to offer annuities as an investment solution within a defined contribution plan, the survey found that a quarter of plan sponsors indicate an increased interest in doing so. Plans with $250 million to $499 million showed the most interest in offering annuities, followed by those with $1 billion to $5 billion. Plan sponsors with more than $5 billion “seem to be undecided,” and 33% of the smallest plan sponsors somewhat or strongly disagree that the SECURE Act has increased their desire to offer annuities in their 401(k) plans.

The report said the need for retirement income has become more important as the US workforce has shifted away from defined benefit (DB) plans and toward defined contribution, or 401(k) plans. It said the structure of defined contribution plans means retirees have limited options to leverage the institutional benefits of their plan as they have to manage risks that were previously managed by defined benefit plans, specifically longevity risk, market risk, inflation risk, interest rate risk, and sequence of returns risk.

“Because the most common distribution type is a lump-sum payout, this can also leave retirees exposed to drawdown risk,” said the report. “With so many variables to manage, many retirees end up seeking help from outside of the DC plan, spending down their balances too quickly, or not spending as much during their retirement as they could have.”