COVID-19’s effect on the markets and the economy has been a setback for U.S. corporate defined benefit (DB) plans.
Much has happened in 2020 tied to the COVID-19 pandemic that has affected DB plans, notes Goldman Sachs Asset Management (GSAM) Chief Pension Strategist Mike Moran. Despite equities bouncing back since the market crash in March, DB plan funded levels are down about 2% year to date, in general, he says.
As DB plans continue to see a lower interest rate environment, the outlook for DB plans is “pretty depressed,” Moran says. “When we run portfolios through our models, we find it will be hard for DB plans to hit their expected return assumptions. Some plans had already lowered their return assumptions during 2020, and we will continue to see lowering.” Offering a preview of an upcoming GSAM DB plan review report, Moran says the firm expects discount rates to remain low, which will put more pressure on expected return assumptions.
“There are a lot of lessons to be learned, some not new, so to be relearned, this year,” Moran says. “For example, the importance of rebalancing. In March and April, that was the No. 1 question we got from clients, and those that did rebalance have done well this year. Plan sponsors should also consider whether they have the right hedging in place, because interest rates can go lower.”
He adds that having the right governance in place is also important. “We’ve seen increased interest in OCIOs [outsourced chief investment officers]. That may be driven by some organizations not spending as much time on their DB plans as they want,” Moran says.
The pandemic could also affect assumptions DB plans use for funding and funding needs. Douglas Anderson, founder of Club Vita, an international provider of longevity data analytics, says the assumptions DB plans use for mortality can be broken into two bets: Observe recent history and use what has happened in the recent past, or—what’s more difficult—decide what to use based on future expectations. “The approach of actuaries to DB plans is to make assumptions about continued improvements,” he says. “False mortality numbers require DB plan sponsors to hold more money in their plans. So predictions of future trends can have a significant impact on the money they need to hold in reserve in their plans.”
Anderson suggests DB plan sponsors should think about the future possibilities and their ability to fund the plan given different outcomes. “They could map out a world in which [President-elect Joe] Biden’s goals reduce the longevity gap and the nation’s average ticks upward,” he says. “Conversely, plan sponsors could consider a scenario in which recent trends continue, with a high level of premature mortality. The difference between the two scenarios would have a substantial impact on DB plan funding.” Anderson notes that these are actions insurance companies take when considering pension risk transfer (PRT) transactions.
“We think the true number of COVID-related deaths is higher than the official count, which shows deaths are 15% higher than in recent years. This is much higher than we see from year to year normally,” Anderson says. “We think there are excess deaths that cannot be linked to COVID directly but indirectly, for example, because of the difficulty of finding care during the disruption related to COVID.”
So, in order for plan sponsors to come up with appropriate assumptions for mortality, they have to do the scenario planning, he adds. “They could take an optimistic view, thinking that frailer people have lost their lives and the U.S. is left with healthier individuals. In that case, there would be lower mortality going forward,” Anderson says. “In addition, they could consider changes in behavior. For example, some individuals now working from home may exercise during the time they would have spent commuting. Simply washing your hands more frequently improves health.”
But Anderson notes that data shows there is a disproportionate impact on longevity based on where one lives. For example, people who live in multi-family housing units are in closer proximity to other people—and presumably are more likely to get sick. That’s why Club Vita advocates that ZIP code-based mortality assumptions are more accurate. In addition, lower-income people are less likely to be able to work from home.
“This clearly demonstrates the value in thinking about micro geographic units,” he says. “We have data on COVID instance by county level, and we correlate that with longevity and life expectancy figures we have for different ZIP code areas.”
The Biden Administration’s Effect on DB Plan Funding
Anderson says study patterns in mortality or longevity show a strong difference in life expectancy according to socioeconomic group. “The national life expectancy number is a blunt instrument that disguises the differences,” he says.
Anderson cites a paper issued by the Society of Actuaries, “Mortality by Socioeconomic Category in the United States,” that suggests only people in the top 20% socioeconomic percentile are seeing improvement in life expectancy at the moment.
Any policies Biden has that pertain to reducing the income differentials between low- and high-earners and that pertain to improving access to health care would have an effect on life expectancy and the mortality assumptions DB plans use, Anderson says.
For example, he says, the move to increase the minimum wage to $15 per hour and to implement employment protections for lower-paid people, such as mandating overtime pay, would reduce the differentials between socioeconomic groups. In addition, better management of the pandemic and protection for employees most likely to be exposed to COVID-19 could have an impact on life expectancy numbers, Anderson says. “Another example is changing the age for claiming Medicare from 65 to 60.”
Moran notes that Biden’s agenda likely will have more impact on defined contribution (DC) plans than DB plans, except for perhaps a reversal of policy about environmental, social and governance (ESG) investing in retirement plans, which would affect both types of plans.
He says that DB plans could have seen a positive impact if there was a “blue wave” as a result of the election.
“Democrats in Congress advocate for a higher second stimulus package, and higher spending among Americans would have helped DB plans,” Moran explains. “It is still to be determined how the Senate ends up, but the expectation for a robust stimulus package and interest rates now may be lower.”
Whether the Senate ends up mostly Republican or Democrat could also affect funding stabilization for DB plans, Moran says. “Funding relief is starting to wear away in 2021, which could mean a potentially notable increase in contribution requirements for some DB plans. Is it possible there will be an extension of relief?” Not getting funding relief would be especially detrimental for plans impacted by COVID-19, he says.
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