Continued Volatility Signals Poor Year for DB Plan Funded Status

Higher contributions can be expected in the future and asset allocation makes a difference, according to firms that track defined benefit plan funded status.

Most firms that track defined benefit (DB) plan funded status reported a small decline in October.

The aggregate funded ratio for U.S. S&P 500 corporate pension plans remained unchanged month-over-month in October to end the month at 82.9%, according to Wilshire Associates. The firm says October’s funded ratio resulted from a 2 percentage point decrease in asset values offset by a 2 percentage point decrease in liability values.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 1% in October to 82% as a result of a decrease in equity markets partially offset by an increase in discount rates, according to Mercer. As of October 31, the estimated aggregate deficit of $441 billion increased by $8 billion as compared with $433 billion measured at the end of September.

The S&P 500 index decreased 2.77% and the MSCI EAFE index decreased 4.06% in October. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased from 2.53% to 2.64%.

“Funded status dropped 1% in October as equity markets pulled back,” said Matt McDaniel, a partner in Mercer’s Wealth business. “A few months ago, additional pension funding relief, which could help mitigate a potential end-of-year market slide, looked promising. However, additional relief looks less likely now. Plan sponsors preparing for 2021 may notice an uptick in cash contributions as interest rate relief from several years ago starts to phase out next year.”

Brian Donohue, a partner at October Three Consulting, also says higher contributions can be expected. “Pension funding relief has reduced required plan funding since 2012, but this relief will gradually sunset. Plans that have only made required contributions in the past can expect significant increases in required contributions over the next couple years under current law,” he says in October Three’s October 2020 Pension Finance Update. “2020 experience, if it persists, will not increase required contributions until 2022, compounding higher funding requirements due to the fading of funding relief.”

Both plans October Three tracks lost less than 1% during the month of October. For the year, Plan A is down more than 5% and Plan B is down almost 2%. 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.

“After recovering most of the early year losses this summer, pension finances slipped over the past two months. Barring a recovery between now and year end, 2020 is looking like a poor, but not catastrophic, year for pension finance,” Donohue says.

Michael Clark, managing director at River and Mercantile, says continued volatility is expected: “With increasing numbers related to the pandemic, there is still ample room for markets and interest rates to significantly move between now and the end of the year. Volatility is still in the forecast for the near future.”

According to River and Mercantile’s Monthly Retirement Update, global stock markets started the month strong, but took a turn for the worse in the last week of the month and ended the month down 2% to 3%. Pension discount rates were up about 0.1% to 0.15% from the previous month, but are still down noticeably for the year. For most pension plans, the equity losses for the month will outweigh the liability gains due to the increase in the discount rate, leading to an overall decline in funded status, the update says.

“As the market volatility continues due to rising coronavirus cases and uncertainty from the election, we expect that funded ratio will remain volatile in the near future,” says Jessica Hart, head of the Outsourced Chief Investment Officer (OCIO) Retirement Practice at Northern Trust Asset Management (NTAM). NTAM estimates the average funded ratio of corporate pension plans declined in October from 82.5% to 82.1%.

Global equity market returns were down approximately 2.4% during the month, according to NTAM. The average discount rate increased from 2.27% to 2.37% during the month, which led to lower liabilities.

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios decreased approximately 0.5% throughout October, with the impact primarily due to poor equity performance. Its calculations indicate the discount rate’s Treasury component increased 18 basis points (bps) while the credit component tightened 10 bps, resulting in a net increase of 8 bps.

Overall, liabilities for the average plan decreased approximately 0.9%, while plan assets with a traditional 60/40 asset allocation fell approximately 1.6%.

Asset allocation matters, according to NEPC’s monthly pension status monitor. The funded status of a typical corporate pension plan saw small changes during October, with total-return plans outperforming liability-driven investing (LDI)-focused plans that hedge interest-rate risk, based on NEPC’s hypothetical open and frozen pension plans.

The funded status of the total-return plan increased by 0.9%, driven by rising interest rates and despite a pullback in equities, NEPC says. The funded status of an LDI-focused plan fell by 0.2% as losses from equities eroded gains from decreasing (hedged) liabilities. The plan is currently 78% hedged, as of October 31.