U.S. Corporate DB Plans Hit Highest Funded Status in Years

Milliman’s analysis of the 100 largest U.S. corporate defined benefit plans found that as of March 31, funding for these plans has hit a 15-year high.

According to the Milliman 100 Pension Funding Index, between the end of February and the end of March, the funded ratio climbed from 102.5% to 105.2%, and the funded status surplus grew from $43 billion to $86 billion. Milliman says this is thanks to discount rates that have climbed 82 basis points over the first quarter.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.07% by the end of 2022 and 4.67% by the end of 2023) and asset gains (10.2% annual returns), the funded ratio would climb to 117% by the end of 2022 and 135% by the end of 2023, according to Milliman. Under a pessimistic forecast (3.17% discount rate at the end of 2022 and 2.57% by the end of 2023 and 2.2% annual returns), the funded ratio would decline to 98% by the end of 2022 and 90% by the end of 2023.

More broadly, Wilshire says the aggregate funded ratio for U.S. corporate pension plans in the S&P 500 increased by an estimated 1.9 percentage points month-over-month in March to end the month at 97.3%.

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The monthly change in funding resulted from a 3.4% decrease in liability values partially offset by a 1.5% decrease in asset values. The aggregate funded ratio is estimated to have increased by 3.8 and 1.9 percentage points over the trailing twelve months and the first quarter, respectively.

“Despite this month’s volatility, highlighted by the over 11% trough-to-peak values intramonth for the FT Wilshire 5000, March’s estimated month-end funded ratio remains at its highest level since year-end 2007, which was estimated at 107.8%, before the Great Financial Crisis,” says Ned McGuire, managing director, Wilshire.

River and Mercantile notes that discount rates continued to push higher during March largely due to increases in Treasury yields. Even with the war in Eastern Europe, equity markets, while volatile, ended the month in positive territory. “The significant rise in discount rates so far in 2022, increases which are pushing close to 1% year-to-date, have fueled funded status increases for almost every pension plan sponsor,” it says in its “US pension briefing – March 2022.”

“The biggest story for pension plans so far in 2022 is the rise in discount rates,” says Michael Clark, managing director in River and Mercantile’s Denver office. “This has come primarily due to the increases in U.S. Treasury yields, and especially at the short end of the yield curve. The rise in short-term rates has largely been driven by Federal Reserve actions to combat the inflationary pressures that we’re currently experiencing. Because of the rise in short-term rates, we’re now entering a phase where on any given day the yield curve is inverted, where short-term rates are higher than long-term rates. This has historically been a warning sign of an impending economic downturn over the next year. While an inverted yield curve is not a sure-fire indicator of future problems, plan sponsors should still be aware of the potential implications.”

According to Insight Investment, U.S. corporate pension plan funded status improved by 0.8% from 95.4% to 96.3% during March. Assets declined by 2.4% and liabilities declined by 3.2%, and the average discount rate increased 26 bps from 3.65% in February to 3.91% in March.

“If we anticipate the Fed continuing to increase rates throughout the year, we may expect similar improvements in funded status for plans that are underhedged,” says Sweta Vaidya, North American head of solution design at Insight Investment. “At that point, it may be worthwhile to consider hedging or de-risking in order to secure those improvements.”

LGIM America’s Pension Solutions Monitor for March estimates that pension funding ratios increased approximately 2.8% throughout March to 96.3% from 93.5%. While asset performance for a typical plan with a traditional asset allocation was muted over the month, the increase in pension plan discount rates was the primary driver for the increase in funding ratios. Their calculations indicate the discount rate’s Treasury component increased 37 bps, while the credit spread component tightened 8 bps, resulting in a 29 basis point increase. Overall, liabilities for the average plan decreased 2.7%, while plan assets with a traditional “60/40” asset allocation rose by approximately 0.22%.

Results for Model Plans

Income Research + Management’s analysis of pensions’ funded status changes in March, developed by Theresa Roy, pension and liability-driven investment (LDI) specialist, found that higher discount rates and positive returns on growth assets in March contributed to funded status gains for all its sample plans.

According to IR+M’s LDI Monitor, its Average Plan funded status increased by 2.4% in March, ending the month at 102.9%. The Average Plan is soft-frozen with a target liability duration of 12 to 14 years, and a target asset allocation of 50% growth assets and 50% fixed-income assets.

Plans with smaller allocations to growth assets experienced muted increases in funded status. IR+M’s End Stage Plan funded status increased by 0.5% and ended March at 106.3%. The End Stage Plan is hard frozen with a target liability duration of 8 to 10 years, and a target asset allocation of 15% growth assets and 85% fixed-income assets.

Plans with larger allocations to growth assets saw greater increases in funded status. IR+M’s Young Plan funded status was 94.9%, up by 3.4% from the prior month. The Young Plan is open and accruing benefits with a target liability duration of 15 to 17 years, and a target asset allocation of 70% growth assets and 30% fixed-income assets.

Both model plans that October Three tracks gained ground last month. Plan A added almost 3%, ending the quarter up 4% to 5%, while the more conservative Plan B gained 1% last month and is now up almost 1% through the first three months of 2022. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

Quarterly Data

Northern Trust Asset Management estimates that the average funded ratio for DB plans in the S&P 500 improved in the first quarter of 2022 ending at 99.3% from 95.9%.

“Negative equity returns were offset by higher discount rates,” says Jessica Hart, head of outsourced chief investment officer retirement practice at NTAM. “As telegraphed, the Federal Reserve delivered its first 25 bp hike since 2018. The central bank communicated a cautious approach to future policy given the Russia-Ukraine uncertainty. For pension plans, maintaining their long bond allocation can reduce future funded ratio volatility, and they can still benefit from rising rates if they are not fully hedged.”

MetLife Investment Management analyzed the daily average pension funded status for companies in the Russell 3000 that sponsor DB pension plans and estimates that as of March 29, the average funded status rose to 104.1%, the highest level in the last 10 years. The average plan ended the quarter at 102.5%, which is the highest of any quarter-end in the last 10 years.

“Despite asset losses, pension funded status improved for most plans during the quarter due to liability decreases,” says Jeff Passmore, LDI solutions strategist at MIM. “Higher discount rates decreased pension liabilities by 10.4% and lifted the average funded ratio to 102.5%.”

NEPC’s Q1 2022 Pension Monitor says the funded status of the total-return plan increased 7.6% in the first quarter as higher yields and lower liabilities outpaced losses from equities. The LDI-focused plan saw funded status gain in the first quarter as interest rates increased and credit spreads widened, offsetting asset losses. The plan is 79% hedged as of March 31.

LGIM America estimates the average funding ratio rose to 96.3% from 92.6% over the quarter based on market movements. “Volatility experienced in the Treasury market shows the importance of decoupling risks that can impact pension plan funded status, such as interest rate and credit spread risk,” says Chris Wroblewski, solutions strategist. “Separating these risks can help plans design and implement a more appropriate LDI strategy. Adopting a completion framework is one way pension plans can manage these risks more effectively through volatile market environments.”

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Tags: Corporate, Defined benefit (db) pension plans, Milliman, Pension

Corporate pensions are better funded than ever, according to a new study released by JP Morgan. The data shows that the top 100 corporate pensions in the United States have finally surpassed the average funded levels achieved pre-2008. The average top-100 corporate plan today is 96.4% funded. Currently, over 70% of the plans studied were at their highest-funded levels ever since the Great Recession.

But the strategies that work for bridging a funding gap are not necessarily appropriate for better funded plans, says Jared Gross, co-author (with Michael Buchenholz) of the study and head of institutional portfolio strategy at JP Morgan.

“We’ve been in an era of gradual but persistent de-risking for the better part of the last 12 to 15 years,” says Gross. “But now that we’ve arrived at a level of funding that gives people more flexibility, it’s useful to step back and consider just how far they should go.”

Gross says that while the old models of asset allocation based on total return maximization did not work, newer models that focus heavily on liability-driven investing are also inefficient.

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“The idea that a plan should be invested almost entirely in duration matched corporate bonds and should not seek any excess return is also outdated,” says Gross. “We are arriving at a point now where risk minimization is going to become increasingly inefficient.”

Gross says that given rising wage inflation, it’s particularly useful if plan sponsors look for assets that offer some degree of inflation compensation like real estate, timber, and alternatives.

“There are many plans that still have populations of active workers, so it may be that inflation is going to be a bigger part of the liability going forward,” says Gross. “If your portfolio is entirely invested in fixed income, you are not going to keep pace with that.”

Gross also notes that 2021 was the first year since 2013 in which both asset returns and actuarial returns operated to the benefit of plan sponsors.

“That sort of situation doesn’t come around very often,” says Gross. “While that usually is a good time to take off some risk, there are other far more interesting ways to reduce risks within the return-seeking portfolio rather than pushing capital further into long duration fixed income that also preserve some degree of outperformance.”

Gross also says that there is a misconception among some plan sponsors that pension surpluses are not useful.

“There is this kind of folklore in the pension community that pension surpluses are nothing more than a trapped asset on the balance sheet that will ultimately be captured by excise taxes,” says Gross. “There’s no truth to that at all.”

Gross says that surpluses can be an important cushion against pension volatility. They can also be important for plan sponsors that want to merge plans or do a 420 transfer, a process in which excess assets are transferred to retiree health accounts.

“Just reaching 100% funding is not really the endpoint that most plans should aspire to,” says Gross.