Market returns in September dealt a blow to defined benefit (DB) plan assets that was greater than the decrease in liabilities from rising interest rates, bringing funded status down, according to DB plan asset managers and consultants.
Barrow Hanley Global Investors estimates that the funded ratio of DB pension plans sponsored by companies in the Russell 3000 decreased to 97.1% as of September 30, from 98.6% as of August 31.
“September saw losses across most monitored asset classes, with the weakest performance in equities and real estate,” says Jeff Passmore, liability-driven investing (LDI) strategist at Barrow Hanley. “However, many plans are likely still above funded ratio thresholds that will lead to incremental pension de-risking.”
The aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies with a duration in line with the FTSE Pension Liability Index – Short decreased by an estimated 0.6 percentage point month-over-month in September to end the month at 93.5%, according to Wilshire. The monthly change in funding resulted from a 3% decrease in asset values partially offset by a 2.4% decrease in liability values.
“September saw the worst monthly decline in U.S. equity values as measured by the FT Wilshire 5000 Index since March 2020,” notes Ned McGuire, managing director, Wilshire.
Legal & General Investment Management (LGIM) America estimates that pension funding ratios decreased approximately 1.1% throughout September, primarily due to weak global equity performance, according to its monthly Pension Solutions Monitor. Its calculations indicate the discount rate’s Treasury component rose 19 basis points (bps) while the credit component tightened 3 bps, resulting in a net increase of 16 bps. Overall, liabilities for the average plan decreased 1.6%, while plan assets with a traditional “60/40” asset allocation declined by approximately 2.8%.
Aon’s Pension Risk Tracker shows S&P 500 aggregate pension funded status decreased in September from 93% to 91.6%. It estimates that DB plan assets saw a 2.4% drop during the month.
Aon says the month-end 10-year Treasury rate increased by 22 bps relative to the August month-end rate, and credit spreads narrowed by 11 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.53% to 2.64%.
According to Northern Trust Asset Management (NTAM)’s estimates, the average funded ratios of DB plans sponsored by S&P 500 companies declined in September from 94.6% to 93.8%. It says global equity market returns were down approximately 4.1% during the month, and the average discount rate increased from 2.42% to 2.56% during the month, leading to lower liabilities.
“We are not expecting the Fed to raise rates anytime soon since their consensus forecasts call for inflation to settle next year. However, persistently high inflation could pull forward rate hike expectations,” says Jessica Hart, head of the outsourced chief investment officer (OCIO) retirement practice at NTAM. “If pension plans experience losses from their long bond portfolios due to rising rates, their liabilities are also expected to decline by at least a similar amount.”
In its September U.S. pension briefing, River and Mercantile says even for plans with modest equity exposure, funded status most likely deteriorated as liability gains were more than offset with asset losses.
However, Michael Clark, managing director in River and Mercantile’s Denver office, also anticipates that the Fed’s sentiments, coupled with continued inflation pressures, indicate rates should continue to move higher between now and the end of the year.
“That should provide welcome news to pension plan sponsors by way of increased discount rates and lower liabilities by year-end,” he says. “While corporate earnings have come in strong, there is still caution due to supply chain concerns, labor shortages, and slow-downs in China moving into the holiday season.”
Insight Investment estimates that DB plan funded status declined from 94.1% to 93.1% in September. Assets decreased by 2.9% and liabilities decreased by 1.8%. The average DB plan portfolio dropped 2.4%, while the average discount rate increased by 14 bps from 2.93% to 3.07%.
However, Sweta Vaidya, head of solution design at Insight Investment, notes that “funded status continues to be robust in 2021, averaging over 90% for the year.”
Income Research + Management (IR+M)’s Funded Status Monitor shows how funded status losses differed by DB plan life stages. Its “Average Plan” funded status decreased by 1.3% in September, ending the month at 101.5%. The Average Plan is a soft frozen plan with a target liability duration of 12 to 14 years and a target asset allocation of 50% growth assets and 50% fixed income assets.
Plans with smaller allocations to growth assets experienced smaller decreases in funded statuses. IR+M’s “End Stage Plan” funded status was unchanged in September and ended at 110.8%. The End Stage Plan is a hard frozen plan with a target liability duration of eight to 10 years, and a target asset allocation of 15% growth assets and 85% fixed-income assets.
Plans with larger allocations to growth assets experienced greater decreases in funded statuses. The firm’s “Young Plan” funded status was 92.7%, down by 1.5% from the prior month. The Young Plan is open and accruing benefits with a target liability duration of 15 to 17 years, and a target asset allocation of 70% growth assets and 30% fixed income assets.
Meanwhile, both model plans October Three tracks lost ground last month. Plan A lost more than 1% in September but remains up more than 9% for the year, while the more conservative Plan B lost almost 1% last month but is still 2% ahead through the first three quarters of the year. 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 and a greater emphasis on corporate and long-duration bonds.
Brian Donohue, a partner at October Three Consulting in Chicago, notes that stocks had their worst month of the year in September. A diversified stock portfolio lost 4% last month but remains up almost 12% for the year. Interest rates climbed 0.15% last month, producing losses of more than 1% on bond portfolios during September. Bonds are now down 2% to 4% for the year, with long-duration bonds performing worst.
Overall, October Three’s traditional 60/40 portfolio lost 3% during September and is now up 5% for the year, while the conservative 20/80 portfolio lost 2% last month and is now down less than 1% through the first three quarters of 2021, according to Donohue.
Corporate bond yields rose 0.15% during September and are now up 0.4% since the end of 2020. As a result, pension liabilities fell about 2% during the month and are now down 3% to 5% for the year, with long-duration plans seeing the largest declines, Donohue says.
Quarterly and Year-to-Date Funded Status Estimates
Wilshire says that although the aggregate funded ratio is estimated to have decreased by 0.6 percentage point during the month of September and saw no change during third quarter, the aggregate funded ratio is estimated to have increased by 5.7 and 10.6 percentage points year-to-date and over the trailing 12 months, respectively
According to Aon’s Pension risk tracker, DB plan liabilities decreased as interest rates were up across the quarter. Ten-year Treasury rates increased by 7 bps over the quarter and credit spreads narrowed by 4 bps, resulting in a 3 bps increase in the discount rate over the quarter for an average pension plan.
Return-seeking assets were slightly negative during the third quarter, with the Russell 3000 Index dropping 0.1%. Bond performance was also negative during the quarter, with the Barclays Long Credit Index losing 0.2% over this time frame. Overall pension assets were down 0.4% over the quarter.
However, Aon estimates that during 2021, the aggregate funded ratio for U.S. pension plans in the S&P 500 has increased from 87.9% to 91.6%. The funded status deficit decreased by $98 billion, which was driven by liability decreases of $118 billion offset by asset decreases of $20 billion year-to-date.
LGIM America announced in its Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, that pension funding ratios declined from 89.9% to 89.7% over the quarter based on market movements. Equity markets saw a decline over the quarter, with global equities falling 1% and the S&P 500 modestly increasing 0.6%.
Plan discount rates were estimated to have increased roughly 9 bps in total, while plan assets with a traditional 60/40 asset allocation decreased 0.5%. These changes resulted in a 0.2% decrease in funding ratios over the third quarter.
“The third quarter saw liabilities fall modestly due to higher Treasury yields and wider credit spreads; however, asset values fell further, contributing to a decrease in funding ratios,” says Chris Wroblewski, solutions strategist at LGIM America. “Volatility experienced in the Treasury market shows the importance of decoupling risks that can impact pension plan funded status, such as interest rate and credit spread risk. Separating these risks can help plans design and implement a more appropriate LDI strategy. Adopting a completion framework is one way pension plans can manage uncompensated risk more effectively through volatile market environments.”
According to NEPC, most U.S. corporate pension plans’ funded status remained relatively flat in the third quarter, despite interest-hedging techniques. With Treasury yields recovering from quarter-long lows and credit spreads inching higher over the three months ended September 30, estimated plan liabilities decreased, but so did asset returns. NEPC estimates that during the third quarter, the funded status of a total-return plan increased a modest 0.1%, underperforming the LDI-focused plan, which increased 0.2%.
NEPC says DB plan sponsors will continue to grapple with the competing objectives of their plans. “In the U.S., the potential for increased taxes under consideration contributed to equity losses in September,” NEPC notes. “The proposed infrastructure bill has a pension relief provision that, if passed, will extend the 5% PPA [Pension Protection Act] rate corridor another five years, effectively ensuring that PPA discount rates cannot fall below 4.75% in the next 10 years. In addition, the Build Back Better bill may result in an increase in corporate tax rates, creating a possible incentive to delay contributions.”
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