Corporate Pensions See Slight Funded Status Boost in May

Markets are rebounding, but discount rates used to measure liabilities are falling, and pension consultants wonder if pending legislation will provide funding relief for plan sponsors.

The rebound in global equity markets offset a decrease in discount rates to drive the estimated aggregate funding level of pension plans sponsored by S&P 1500 companies up by 1 percentage point in May, according to Mercer.

The funding level as of May 31 was 81%, as the estimated aggregate deficit of $476 billion decreased by $14 billion as compared with $490 billion measured at the end of April. The S&P 500 index increased 4.53% and the MSCI EAFE index increased 4.07% in May. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased from 2.77% to 2.69%.

“Equity volatility has continued to decrease, and during May we saw healthy improvements in both U.S. and international markets. However, funded status is still down 7% since the beginning of the year,” notes Scott Jarboe, a partner in Mercer’s Wealth business. “But there is some good news for plan sponsors. The House recently passed another stimulus bill, the HEROES [Health and Economic Recovery Omnibus Emergency Solutions] Act, which includes immediate and longer-term funding relief provisions. However, now the bill moves to the Senate and negotiations are expected to take considerable time before potential agreement on a final bill.”

The aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies increased by 0.8 percentage points in May to end the month at 82%, according to Wilshire Consulting. Ned McGuire, managing director and a member of the investment management and research group of Wilshire Consulting primarily attributes the gain to the increase for global public equities.

Wilshire says the monthly change in funding resulted from a 1.8% increase in asset values partially offset by a 0.8% increase in liability values. The aggregate funded ratio is estimated to have decreased by 6.6 and 5.1 percentage points year-to-date and over the trailing 12 months, respectively.

Northern Trust Asset Management (NTAM)’s projections show a funded ratio improvement for S&P 500 pension plans from 78.3% to 79.8% in May. The asset manager says global equity market returns were approximately 4.4% during the month. The average discount rate decreased from 2.40% to 2.38% during the month, leading to higher liabilities.

Legal & General Investment Management America (LGIMA) estimates that the average plan’s funding ratio increased 1.8% to 75.2% throughout the month. It says U.S. stocks (4.8%) outperformed international stocks (4.4%), developed markets outperformed emerging, growth stocks outperformed value stocks, and small cap (6.5%) outperformed large cap (4.8%). However, small caps are still trailing substantially year to date. Volatility continued to fall from extreme levels in both risk and safe haven assets but remains significantly elevated, notably in medium-term risk.

LGIMA says, overall, liabilities for the average plan increased approximately 0.3%, while plan assets with a traditional “60/40” asset allocation increased by approximately 2.8%.

Both model plans October Three tracks gained ground last month, with Plan A improving 2% and plan B up almost 1%. For the year, Plan A is down 10% and Plan B is down 3%. 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.

Brian Donohue, partner at October Three Consulting, notes that under current law, pension funding relief will gradually sunset. “Given the current level of market interest rates, it is possible that relief reduces the funding burden through 2030,” he says, “but the rates used to measure liabilities will move significantly lower over the next few years, increasing funding requirements for pension sponsors that have only made required contributions.”

Donohue adds that if 2020 experience persists, it will not increase required contributions until 2022, compounding higher funding requirements due to the fading of funding relief.

Commenting about River and Mercantile’s latest Retirement Update, Michael Clark, managing director at the firm, says, “Average pension plan funded status is still down from the beginning of the year, but should have rebounded slightly in May. The first week of June saw markets, as well as interest rates, up on good news regarding employment numbers and additional stimulus around globe. What happens next will largely depend on the any additional economic fallout from the first wave of COVID-19 and any potential second wave of cases that arise from states reopening their economies.” Clark also mentions that it’s unclear if provisions of the HEROES Act will make it through negotiations with the Senate, but if they do, they will result in a decrease in required contributions for most plans in 2020 and the next few years to come. “That will be welcome news for plans that are sensitive to cash requirements today and provide flexibility around contribution strategy for everyone else,” he says.

Aon’s Pension Risk Tracker shows that pension funded status remained relatively flat from April to the end of May, decreasing slightly from 85.3% to 85.2%. The month-end 10-year Treasury rate increased by 1 basis point (bp) relative to the April month-end rate, and credit spreads narrowed by 18 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 2.87% to 2.7%. “Given a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates offset the positive effect of asset returns on the funded status of the plan,” the firm says.