Corporate Pension Funded Status Breaks Two-Month Losing Streak
The rest of the year could be promising for DB plans, depending on the Fed’s stance on interest rates and the effect of the infrastructure bill and the Delta variant on the markets.
The aggregate funded ratio for U.S. corporate pension plans of S&P 500 companies increased by an estimated 1.2 percentage points month-over-month in August to end the month at 94%, according to Wilshire.
The monthly change in funding resulted from a 0.7% decrease in liability values compounded by a 0.6% increase in asset values. The aggregate funded ratio is estimated to have increased by 6.2 and 9.8 percentage points year-to-date and over the trailing 12 months, respectively.
“August’s funded ratio increase snapped two consecutive months of funded ratio decreases,” says Ned McGuire, managing director at Wilshire. “It was driven by the decrease in liability values as Treasury yields increased month-over-month for the first time since March, and the continued increase in asset values highlighted by the seventh consecutive monthly increase in U.S. equity values, as measured by the FT Wilshire 5000 Index.”
Insight Investment’s monthly model shows corporate defined benefit (DB) plan funded status improved by 1% in August, reaching 94.1%. The gain was driven by strong equity returns and a rise of 6 basis points (bps) in the discount rate. It says assets increased by 0.3% and liabilities decreased by 0.08%.
S&P 500 aggregate pension funded status increased in August from 92.4% to 92.9%, according to the Aon Pension Risk Tracker. Pension asset returns were up and down throughout August, ending the month with a 0.8% return.
According to Aon, the month-end 10-year Treasury rate increased 6 bps relative to the July month-end rate, and credit spreads narrowed by 5 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.52% to 2.53%. “Given a majority of the plans in the U.S. are still exposed to interest rate risk, the decrease in pension liability caused by increasing interest rates compounded the positive effect of asset returns on the funded status of the plan,” Aon says.
According to NEPC’s Pension Monitor, in August, corporate pension plans likely experienced gains in funded status as interest rates improved marginally and equity performance was broadly positive. Rising rates led to lower estimated liabilities and negative performance for fixed-income mandates.
NEPC says total-return plans with larger equity allocations likely experienced greater improvement in funded status relative to plans that use liability driven investing (LDI). Based on NEPC’s hypothetical open- and frozen-pension plans, the funded status of the total-return plan improved 2.4%, while the LDI-focused plan improved 1.7% last month.
Both model plans October Three tracks gained ground last month. Plan A improved close to 2% in August and is now up almost 11% for the year, while the more conservative Plan B gained a fraction of 1% last month and is now up almost 3% through the first eight months of the year. 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 and a greater emphasis on corporate and long-duration bonds.
“Pensions enjoyed a great first quarter this year, before giving back some early year gains during the April to July period, but August delivered a nice bounce back for pension finance, which is on track for its best year since 2013,” says Brian Donohue, a partner at October Three Consulting in Chicago.
LGIM America estimates that pension funding ratios increased approximately 1.6% throughout August, primarily due to the strong global equity performance. Its calculations indicate the discount rate’s Treasury component rose 3 bps while the credit component widened 2 bps, resulting in a net increase of 5 bps. Overall, liabilities for the average plan decreased 0.3%, while plan assets with a traditional 60/40 asset allocation grew by approximately 1.4%, according to LGIM America’s Pension Solutions Monitor.
According to Northern Trust Asset Management, the average funded ratio for DB plans of S&P 500 companies improved in August from 93.3% to 94.6%. Global equity market returns were up approximately 2.5% during the month. The average discount rate increased from 2.38% to 2.42% during the month, leading to lower liabilities.
Jessica Hart, head of the outsourced chief investment officer (OCIO) retirement practice at Northern Trust Asset Management, says, “Interest rates have stabilized recently as Fed Chair [Jerome] Powell mentioned that potential reduction in asset purchases will not automatically trigger a rise in interest rates shortly thereafter. Inflation has made progress toward the Fed’s goal and employment reports indicate labor market progress.”
Pension discount rates experienced a slight increase in August after several months of a downward trend, River and Mercantile notes in its “US Pension Briefing – August 2021.” This means pension plan liabilities decreased slightly from the prior month. Overall discount rates are still approximately 0.2% higher than they started the year—meaning liabilities should generally be lower than they were at the end of 2020. Equity markets were up as well, so a typical pension plan should see an improvement in its overall funded status for the month of August with decreasing liabilities and positive asset returns.
“A lot could still happen with pension discount rates between now and the end of the year,” says Michael Clark, managing director and consulting actuary with River and Mercantile. “The biggest drivers of where rates go will depend on actions from the Fed, fiscal stimulus (i.e., the $3.5 trillion infrastructure bill) and the effects of the Delta variant on global economies. We don’t expect the Fed to take any action between now and the end of the year, especially with last week’s jobs report. If the infrastructure bill passes, that could provide an additional boost to markets and move rates higher. If the Delta variant doesn’t substantially impede economic growth, it’s not hard to see rates rising between now and year-end. However, if the variant creates more headaches for global economies, we might be stuck where we’re at.”
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