Increased Pension Fund Liabilities Overrode Investment Returns in March

With the collapse of Silicon Valley Bank in March and a sharp decrease in fixed income yields, most analysis firms found that corporate pension funding statuses fell last month. However, not all analysts agreed on this finding, as one firm reported that funded ratios increased slightly in March. 

Wilshire Associates reported that the aggregate funded ratio for U.S. corporate pension plans decreased marginally, at an estimated 0.6 percentage points, month-over-month in March to end the month at 99.1%. 

This slight decrease in funded status resulted from a 3.4% increase in liability value partially offset by a 2.7% increase in asset value, according to Wilshire. Although the aggregate funded ratio is estimated to have decreased by 0.6% in March, the aggregate funded ratio is estimated to have increased by 1.6% and 1.4% in the first quarter and over the trailing 12 months, respectively. 

“March’s funded status decrease was driven by the increase in liability value resulting from the sharp decrease in fixed-income yields,” stated Ned McGuire, the managing director of Wilshire. “Fixed-income yields fell on the heels of the collapse of Silicon Valley Bank, with market expectations pivoting to federal funds rate cuts in 2023.” 

Compared to March, corporate pension plan sponsors experienced increased funding levels in February, as falling stock markets offset the impact of higher interest rates.  

Insight Investment also found that funded statuses declined in March by 1.6% to 102.3% from 103.9%. Sweta Vaidya, Insight’s North American head of solution design, said the decline was driven by a 25 bps decrease in discount rates, which increased liabilities and reduced funded status despite positive equity returns over the month. 

“Last month’s events in the banking sector have heightened concerns about the stability of regional banks, concentration of investments, a pivot in Fed policy and a potential recession,” Vaidya said in a statement. “Now is the time to assess whether your investment programs are resilient enough to withstand what may lie ahead.” 

For March, Insight Investment found that assets, which on average are invested in 50% fixed income and 50% equities and alternatives, increased by 1.4% and liabilities increased by 2.9%.  

LGIM America’s Pension Solutions Monitor, which estimates the health of a typical U.S. corporate defined benefit pension plan, estimated that pension funding ratios increased to 100.3% from 99.9% in March.  

As equity markets showed a strong performance, with global equities up roughly 3.2% and the S&P 500 up 3.7%, plan discount rates were estimated to have decreased roughly 30 bps over the month—with the Treasury component decreasing 34 bps and the credit component widening 4 bps, according to LGIM. 

Plan assets with a traditional “50/50” asset allocation also increased 3.8%, while liabilities increased 3.4%, resulting in a slight improvement in funded ratios by March month-end. LGIM said funding ratio levels were relatively unchanged because the strong performance on the asset side was offset by the rise in liabilities.  

Meanwhile, according to WTW’s Pension Finance Watch, the firm’s Pension Index declined in March, as a result of an increase in liabilities due to a decrease in discount rates. This was partially offset by investment returns. The March 31 index level of 100.6 reflects a decrease of 0.7% in funded status for the month, WTW reported. 

The equity portion of WTW’s benchmark portfolio returned 2.2% in March, and fixed-income investments in the portfolio had a positive return of 2.3%, with long Treasury bonds and long corporate bonds experiencing the largest gains. Meanwhile, yields on high-quality corporate bond indices decrease an average of 27 bps, according to WTW. 

Since liabilities in WTW’s index increased by 3%, this caused pension status to decline.  

In addition, Mercer found that pension plans sponsored by S&P 1500 companies decreased by 1% in March to 102%, as result of a decrease in discount rates partially offset by an increase in equity markets.  

As of March 31, the estimated aggregate surplus of $28 billion decreased by $25 billion, as compared to a surplus of $53 billion measured at the end of February, according to Mercer.  

“The recent bank troubles have startled markets, but at this point the key impact is that rates have decreased as many believe the Fed will end rate increases soon to try and avoid further bank troubles,” said Scott Jarboe, a partner in Mercer’s wealth Business, in a statement. “This remains to be seen, but as markets keep a close eye on the banking situation, rates and the Fed, plan sponsors should continue to evaluate their risk position. Doors to various risk transfer strategies could open and close fairly quickly if market volatility continues throughout this year.”  

Aon’s U.S. Risk Transfer report for March 2023 revealed that rising interest rates drove increased pension risk transfer activity in 2022.  

Agilis’s March 2023 U.S. pension briefing found that even with the turmoil that occurred in the banking sector, the economy continued to grow in March and the job market remained strong, in spite of more layoff announcements and higher wage costs. Inflation is also coming down slowly, but Agilis said it remains “stubbornly higher” than the Fed’s long-term target of 2%.  

“The Fed continues to raise rates while market sentiment is pushing Treasury yields down,” Agilis managing director Michael Clark said in a statement. “The stark contrast in views is going to continue to introduce volatility into the economy, which will affect pension discount rates and asset returns. Who is ultimately right between the Fed or markets will largely be driven by what happens in the labor market, the persistence of inflation over the coming months, and any additional tail events (e.g. bank failures, geopolitical escalation). Pension plan sponsors are most likely in for a continued bumpy ride in 2023.” 

Agilis analysts concluded that funded status for most pension plans decreased in March as liability growth outpaced investment returns. The fall in government yields also outweighed an increase in spreads, which resulted in falling discount rates in March, Agilis stated. 

For most pension plans, Agilis found that the fall in discount rates raised liabilities by more than the growth in equities, leading to deterioration of funded status.  

October Three also found that pension finances slipped in March as interest rates moved lower and outpaced modestly rising stock prices. 

Each model allocation at the firm gained about 3% in March. The firm’s traditional 60/40 portfolio gained about 6% on its assets, while the conservative 20/80 portfolio improved about 4% through the end of the first quarter.  

Because corporate bond yields fell 0.3% in March, October Three found that pension liabilities rose between 3% to 4% during the month, ending the quarter around 4% to 6% higher. 

Even though pension funding relief was signed into law in March and November of 2021, substantially relaxing funding requirements over the next several years, October Three argued that the increase in rates seen in the past year has “eroded the impact of relief.” 

As discount rates moved 0.3% lower last month, October Three predicts most pension sponsors will use effective discount rates in the 4.7% to 4.9% range to measure pension liabilities right now.