US Corporate Pension Funding Rises Slightly in September

U.S. corporate pension funding status increased in September, despite a decline in equities. September’s funding status was a return to the norm, following an August that saw pension funding decline for the first time this year.

Insight Investment found that pension funding status improved by one percentage point in August, to 107.5% from 106.5%. Equity losses were offset by a roughly 40 bps increase in discount rates, causing liabilities to decline faster than assets. Assets decreased by 4.5% in September, while liabilities decreased by 5.4%. Asset returns were negative 3.9%, and liability returns were negative 4.7% for the month. Insight Investments’ model follows the funding status of the top 100 corporate pension plans in the U.S.

“As funded statuses continue to rise towards the end of the year, we are having more conversations about end-state objectives: pension risk transfer or self-sufficiency,” said Sweta Vaidya, head of solution design at Insight Investment, in the report. “More plan sponsors are considering long-term self-sufficiency and exploring how they may be able to extract value from their pension surplus.”

Treasury Rate Increases as Credit Spreads Narrow

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Aon also reported an increase in the aggregate funding ratios within corporate pension plans in the S&P 500. Aon’s tracker found that pension funding increased 0.8 percentage points, to 102.3% from 101.5%, in September. Pension assets declined in September, with a negative 3.9% return.

“The month-end 10-year Treasury rate increased 50 bps relative to the August month-end rate, and credit spreads narrowed by 3 bps,” Aon’s report stated. “This combination resulted in an increase in the interest rates used to value pension liabilities from 5.32% to 5.79%. Given a majority of the plans in the U.S. are still exposed to interest-rate risk, the decrease in pension liability caused by increased interest rates offset the negative effect of asset returns on the funded status of the plan.”

The rise in interest rates resulted in pension liabilities decreasing in the quarter as well. With 10-year Treasuries up 78 bps and credit spread narrowing by 7 bps, the discount rate increased by 71 bps for an average pension plan in Aon’s tracker.

The firm reported that return-seeking assets declined in the year’s third quarter, with equities represented by the Russell 3000 Index returning negative 3.3%. Bonds were also negative, with the Barclays U.S. Long Credit Index returning negative 7.2%. In total, pension assets returned negative 4.6% in the third quarter.

Wilshire Advisors estimated the aggregate funded ratios for U.S corporate pension plans increased by 0.7 percentage points in September, roughly in line with other firms. Wilshire found pension plan funding increasing to 105.3% by the end of September.

Aggregate funding ratios increased, as a 5.4% decrease in the value of pension liabilities was offset by a 4.8% decrease in the value of pension assets.

“September’s funded status increase was driven by the continued rise in Treasury yields, causing the liability value to experience its largest monthly decline since September 2022,” Ned McGuire, Wilshire’s managing director, said in a statement. “Corporate bond yields, used to value corporate pension liabilities, are estimated to have increased by over 45 basis points.”

Although most asset classes posted negative returns in September, with the FT Wilshire 5000 Index posting its worst monthly performance of the year, the September aggregate funded ratio is still one of the highest in recent years.

“September’s month-end funded ratio estimate of 105.3% is the highest since December 2012, when Wilshire began reporting month-end funded ratio estimates, and is approaching the funded ratio of 107.8% before the Great Financial Crisis [of 2008 and 2009].”

LGIM America Reports Funding Ratio Decrease

While most analytics firms reported an increase in pension funding in September, LGIM America found otherwise. According to LGIM America’s Pension Solutions Monitor, the average funding ratio declined one percentage point, to 102.6% from 103.6%, in September.

LGIM America’s Pension Solutions Monitor estimated the health of U.S. corporate defined benefit pension plans assuming a typical liability profile using an approximate duration of 12 years and a “traditional” 50/50 asset allocation with a portfolio construction that is 50% MSCI ACWorld total gross index and 50% Bloomberg U.S. long government/credit index.

LGIM attributed the decline to weak equity performance in September. Equities declined 4.1% in September, with the S&P returning negative 4.8%. LGIM estimated pension plan discount rates increased 50 bps. LGIM reported the Treasury component increasing 52 bps, with the credit component tightening 2 bps. Assets in LGIM’s 50/50 asset allocation portfolio declined 5.2%, with liabilities declining 4.2%, resulting in a decline in the aggregate funded status.

Conversely, October Three noted in its September pension finance update that a decline in equities was largely offset by higher interest rates, which is a common theme across the board.

The October Three pension tracker tracks two models: Plan A, a traditional 60/40 equities to bond portfolio, and Plan B, a retired plan with a 20/80 allocation, with an emphasis on corporate and long duration bonds. Plan A was flat for the month, but up eight percentage points for the year. Funding status in Plan B declined slightly in September, but its funded status remained at roughly 101%, one percentage point higher than the start of the year.

The lag in funding status in Plan B can be attributed to a decline of between 3% and 5% in bonds last month, a result of Treasury yields rising 0.5% and corporate bond yields rising 0.4% in September.

Milliman Predicts Ratios Could Reach 107% by Year-End

According to Milliman’s Pension Funding Index, which tracks the 100 largest U.S. corporate defined benefit pension plans, pension funding ratios increased 0.43 percentage points to 103.6%. For the year to date through September, the Milliman 100 PFI has increased 1.7 percent.

Milliman projected funded status ratios to rise to 103.6% by the end of 2023, in a scenario in which assets return 5.8% on average, if the current discount rate of 5.84% was maintained. In Milliman’s most optimistic scenario, assets could return 8.8% per year, with funding ratios rising to 107% by the end of 2023 and 119% by the end of 2024. That scenario assumes that interest rates would rise to 5.99% by the end of this year and 6.59% by the end of 2024.

“September was a record month of sorts, even though the net movement in funded ratio was modest,” said Zorast Wadia, author of the PFI, in the monthly report. “September returns were the lowest of the year, yet the rise in discount rates was the largest monthly change we’ve seen in the last 12 months. In the end, this rise and the corresponding $60 billion liability drop outweighed September’s decrease in assets due to down markets.”

In Milliman’s pessimistic projected scenario, with interest rates declining to 5.69% at the end of the year and 5.09% at the end of 2024 and with assets returning 1.8%, corporate pension funding ratios would decline to 101% at the end of 2023 and 92% at the end of 2024, according to Milliman.

Agilis reported in its pension funding update that pension discount rates last month were the highest in more than a decade. Agilis also found that pension funds, in general, maintained or slightly improved their funding status in September.

“The surge in discount rates in September resulted in a 3.5%-6.5% decrease in pension liabilities depending on duration,” Michael Clark, managing director at Agilis, said in a statement. “However, nearly all asset classes, including equities and fixed income, experienced negative returns, largely offsetting the gains in funding achieved through higher discount rates. Consequently, many pension plans are expected to see only a modest improvement in their funded status.”

Finally, WTW reported that its WTW Pension Index increased 1.4 percentage points to 109.4% in September. Like others, WTW reported that reductions in liabilities, as a result of increases in discount rates, offset negative asset returns.

Tags: Agilis, Aon, Aon Pension Risk Tracker, Insight Investment, Legal & General Investment Management (LGIM), LGIM America’s Pension Solutions Monitor, Michael Clark, Milliman, Milliman 100 Pension Funding Index, Ned McGuire, October Three Consulting, Sweta Vaidya, Wilshire Advisors, WTW, WTW Pension Finance Watch, Zorast Wadia

Despite its dip over the past two months, the stock market still has logged a good performance this year, with the S&P 500 up 12.2% as of Friday. Still, this run, a heartening bounce back from 2022’s carnage, has left equities expensive: Using reported earnings, the index’s trailing price/earnings ratio is up to 23.2, ahead of its long-term average by about seven percentage points.

Those lofty valuations are an impediment for stock buyers. But stocks will not maintain that high altitude for long, according to David Rosenberg, an influential economist, who previously served as the top North American economist for Merrill Lynch (now part of Bank of America). Reason: The U.S. economy is shakier than it may appear.

In a research note, Rosenberg wrote that “these high P/E multiples look unsustainable in the face of a high-for-longer Fed and a ridiculous 100 basis point equity risk premium.”

Now the head of his own shop, Rosenberg Research and Associates Inc., Rosenberg argued it is absurd for investors to “take on the risk at these relative valuation levels” when there is a lot of evidence that today’s high P/E levels are sure to decline, along with the market.

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Indeed, the Federal Reserve signaled, in its September meeting, that it intends tomaintain current interest rate levels for a while, dashing the hopes of bulls who expected the Fed to ease somewhat. The central bank’s campaign, underway since early last year, to hike the benchmark rate to more than 5% from near zero, appears unlikely to flag. Last Friday’s strong jobs report buttressed the case for a sustained level of relatively high rates for now, Rosenberg stated.

The equity risk premium (the difference between the index’s earnings yield and the 10-year Treasury yield) now stands at a mere 0.7 percentage point. Over the past dozen years, the average has been more than 5 points.

Rosenberg pointed to evidence that the U.S. economy may be starting to crack: The Conference Board’s leading economic indicators have fallen for 17 consecutive months, the Institute for Supply Management’s purchasing managers’ index is in contraction mode (namely below 50—it was at 49 in September) and credit card delinquency rates are rising. Add in slowing growth for U.S. gross domestic product and similar woes in Europe, Japan and China, and the picture is not bright for continued stock increases, Rosenberg opined.

Meanwhile, he accused the Fed of having “a complacent view on the U.S. economic outlook” as it winds down its huge inventory of bonds. All of this is going to “catch a whole lot of macro bulls by surprise,” he noted.