DB Plan Sponsors Should Act Now to De-Risk and Lock In Funding Gains

With most companies that track defined benefit (DB) plan funded status showing an improvement in April and for the year, some suggest plan sponsors consider whether it’s time for a risk transfer or to set off portfolio glide path triggers.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased by two percentage points in April 2019 to 90%, as a result of an increase in equity markets and discount rates, according to Mercer.

As of April 30, 2019, the estimated aggregate deficit of $232 billion decreased by $41 billion as compared to $273 billion measured at the end of March. The S&P 500 index increased 4.05% and the MSCI EAFE index increased 2.91% in April. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased from 3.78% to 3.84%.

“Despite interest rate levels remaining low, we continue to see significant risk transfer activity, particular in the lump sum area where 2019 interest rate conditions are favorable,” says Scott Jarboe, a partner in Mercer’s U.S. Wealth business. “Plan sponsors waiting for sustained higher interest rates to act may be missing opportunities to lock-in funded status improvements and de-risk balance sheets as the 2019 bull market has continued.”

Dan Kutliroff, head of OCIO Business Strategy at Northern Trust Asset Management (NTAM), says, “April markets brought another month of improved funded status in pensions as the 2019 equity markets continue to help pensions climb back from the fourth quarter downturn of 2018.  Plans that have adopted automated de-risking glide paths can potentially limit their exposure to some of this volatility as they shift more of their assets to fixed income assets that behave similarly to the liabilities, as their funded status hits certain trigger points.”

According to NTAM, in April, the average funded ratio improved from 87.8% to 89.6%. Positive gains in the equity market along with lower liabilities led to favorable results in funded ratios. Global equity markets were up approximately 3.4% during the month. The average discount rate increased from 3.45% to 3.51% during the month, leading to lower liabilities.

River and Mercantile reports that the month of April increased funded status gains since the beginning of the year. For most plans, gains since the beginning of the year should be up by about two to three percentage points.

Asked how a plan sponsor knows if it is close to the point where it can terminate its plan, River and Mercantile says, “Frozen plans need to keep their eyes on termination liability since surplus in a frozen plan has very limited value. Monitoring plan termination liability closely makes a lot of sense so sponsors can reduce funded status risk as assets close in on plan termination liabilities. Given that funded status has bounced back in 2019, it may be time to assess risk levels and protect funded status for frozen plans.”

Legal & General Investment Management America (LGIMA) estimates pension funding ratios increased in April to 87.4% from 85.6%, driven primarily by positive equity returns. It estimates the discount rate’s Treasury component increased by 12 basis points (bps) while the credit component decreased 9 bps, resulting in a net increase of 3bps. Overall, liabilities for the average plan decreased 0.15%.

According to LGIMA, defined benefit (DB) plan sponsors are exploring the potential benefits of using a Treasury or equity overlay. Using an equity overlay allows plan sponsors to maintain the portfolio’s equity allocation while investing more capital in physical bonds. A Treasury overlay reduces the plan’s interest rate risk.

The aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies increased by 2.0 percentage points, reversing March’s decline, to end the month of April at 88.6%, according to Wilshire Consulting.

It reports that the monthly change in funding resulted from a 1.6% increase in asset values and a 0.8% decrease in liability values. The aggregate funded ratio is up 4.1 percentage points year-to-date, and flat over the trailing twelve months.

The Aon Pension Risk Tracker shows S&P 500 aggregate pension funded status increased in April from 87.8% to 89.4%. Pension asset returns experienced steady growth in April, ending the month with a 1.4% return. The month-end 10-year Treasury rate increased by 10 bps relative to the March month-end rate and credit spreads narrowed by 3 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 3.54% to 3.61%.

According to October Three, pension finances bounced back in April due to higher stock prices and higher interest rates. Both model plans it tracks gained ground last month: Plan A added more than two percentage points and is now up almost five percentage points for the year, while Plan B gained close to one percentage point and is now up two percentage points through the first four months of 2019. 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.

Overall, October Three’s traditional 60/40 portfolio gained 2% in April and is now up 11% for the year, while the conservative 20/80 portfolio gained less than 1% last month and is up 7% during 2019. Corporate bond yields rose less than 0.1% in April, decreasing pension liabilities less than one percentage point. For the year, liabilities remain up five to seven percentage points, with long duration plans seeing the largest increases.