After December wiped out all funded status gains for defined benefit (DB) plans last year, firms that track funded status estimate 2% to 3% improvement for the first month of 2019.
The estimated aggregate funding level of pension plans sponsored by Standard & Poor’s (S&P) 1500 companies increased by 3% last month to 88%, as a result of an increase in U.S. equity markets, according to Mercer. As of January 31, the estimated aggregate deficit of $262 billion decreased by $50 billion as compared with $312 billion measured at the end of December.
The S&P 500 index increased 7.87%, and the MSCI EAFE index increased 6.47% in January. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased by 15 basis points (bps) to 4.04%.
“Even though January was a solid improvement in equities, there is still much uncertainty in the market as evidenced by persisting volatility. We expect plan sponsors will continue to keep a close eye on markets and look for opportunities to lock in gains as opportunities arise,” says Matt McDaniel, a partner in Mercer’s U.S. wealth business.
According to Wilshire Associates, the aggregate funded ratio for U.S. corporate pension plans increased by 2.8 percentage points to end January at 87.3%. The monthly change in funding resulted from a 5.5% increase in asset values partially offset by a 2.2% increase in liability values. The aggregate funded ratio was down 1.6 percentage points over the trailing 12 months. The aggregate figures represent an estimate of the combined assets and liabilities of corporate pension plans sponsored by S&P 500 companies with a duration in line with the FTSE Pension Liability Index – Intermediate.
“January’s bounce back in funded ratios was propelled by the best monthly percentage increase for the Wilshire 5000 in more than seven years,” says Ned McGuire, managing director and a member of the pension risk solutions group of Wilshire Consulting. “January’s 2.8 percentage point increase in funding was the largest monthly increase over the past 12 months and follows December’s 6 percentage point decline.”
The aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 84.9% to 86.5% last month, according to the Aon Pension Risk Tracker. The funded status deficit decreased by $27 billion, which was driven by an asset increase of $66 billion, offset by liability increases of $39 billion year-to-date.
Pension asset returns experienced steady growth during January, ending the month with a 4.3% return.
According to Aon, the month-end 10-year Treasury rate decreased by 6 bps relative to the December month-end rate, and credit spreads narrowed by 11 bps. This combination resulted in a decrease, from 3.96% to 3.79%, in the interest rates used to value pension liabilities. Given that 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 slightly counteracted the positive effects from asset returns on the funded status of these plans.
Northern Trust Asset Management (NTAM) also found that corporate pension plans’ average funded ratio improved, from 83.8% to 85.9%, last month. The increase was primarily driven by a sharp rise in assets that was partially offset by a decrease in discount rates. Global equity markets were up approximately 8% during the month. The average discount rate decreased from 3.91% to 3.75%.
Legal & General Investment Management America (LGIMA) estimates the average defined benefit plan’s funding ratio increased 2.1% to 86.5% in January. Speaking of the improved market returns, a representative for LGIMA says, “A change in the Fed’s tone has certainly contributed to the recovery—the comments on flexibility regarding rate and balance-sheet-size decisions have contributed to a general sense that, despite its claims to the contrary, the Fed is increasingly dovish and attuned to risk markets. But beyond this, it is hard to pinpoint any other specific catalysts for the rebound.”
Both model plans that October Three tracks improved last month: Plan A gained almost 3%, while Plan B gained about 1%. 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, the emphasis being greater on corporate and long-duration bonds.
According to October Three, January was a very good month for stocks, and bonds gained ground as well, driven by lower interest rates. Overall, the firm’s traditional 60/40 gained 5% to 6%, while the conservative 20/80 portfolio grew about 3%. Corporate bond yields fell 0.15%, pushing pension liabilities up 2% to 3%.
Looking ahead, Brian Donohue, a partner at October Three, says, “Pension funding relief has reduced required plan funding since 2012, but relief is expected to gradually sunset over the next three to four years, increasing funding requirements for pension sponsors that have made only required contributions. Discount rates moved down last month. We expect most pension sponsors will use effective discount rates in the 3.9% to 4.3% range to measure pension liabilities right now.”
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