Q1 2021 Has DB Plan Sponsors Saying ‘What? Me? Worried?’

The average funded ratio of corporate pension plans improved in March from 91.3% to 93.5%, according to Northern Trust Asset Management (NTAM). Positive returns in equities, along with an increase in discount rates, led to the higher funded ratio.

NTAM says global equity market returns were up approximately 2.7% during the month. The average discount rate increased from 2.61% to 2.80% during the month, leading to lower liabilities.

“As discount rates increased by more than 70 bps [basis points] year-to-date, long bonds in portfolios lost value. However, the typical pension liability declined by a larger amount. This dynamic, combined with favorable equity returns, resulted in the improvement of average pension funded ratios,” says Jessica Hart, head of the Outsourced Chief Investment Officer (OCIO) Retirement Practice at NTAM.

River and Mercantile says defined benefit (DB) plans, particularly those with higher equity allocations, should have seen a funded status improvement in March. In its “US Pension Briefing – March 2021,” the firm notes that pension discount rates continued increasing last month, and are up 0.7% so far in 2021, which once again means lower liabilities for pension plan sponsors. Equity market returns were almost universally positive for the month due to the continuing rollout of COVID-19 vaccines.

“The combination of rising rates and positive equity returns over the last nine months has translated into a string of month-over-month funded status improvements for many plan sponsors. This, coupled with the funding relief provisions in the March stimulus bill, should give plan sponsors some breathing room to reassess their current pension risk management framework,” says Michael Clark, managing director and consulting actuary with River and Mercantile. “With contribution requirements slashed for many plan sponsors and contribution volatility significantly reduced, now is when plan sponsors need to reassess their overall funded status risk profile and decide how to best move forward.”

The stimulus bill, known as the American Rescue Plan Act (ARPA), was signed into law March 11 and includes relief provisions for both single-employer and multiemployer DB plans. The law provides flexibility in single-employer plan sponsors’ cash contribution requirements by changing the interest rate corridors and extending the amortization periods used to calculate minimum contributions.

Insight Investment measured a DB plan funded status increase from 88% as of February 28 to 90% as of March 31. “Discount rates rose another 25 bps in March, bringing the year-to-date rise in discount rates to approximately 70 bps. Asset returns are level to slightly up on the year as the losses in fixed income due to rising rates offset by gains in the return seeking asset portfolio,” comments Kevin McLaughlin, head of liability risk management – North America at Insight Investment.

Brian Donohue, a partner at October Three Consulting, adds, “What a difference a year makes! A year ago, pension sponsors were looking at a 10% or greater hole in pension finances. The hole reversed by the end of 2020, and this year, funded status has jumped markedly in the first quarter, driven by higher interest rates and steady stock markets.”

Both model plans October Three tracks gained ground last month. Plan A gained 4% and is now up more than 11% for the year, while the more conservative Plan B added 1% and is now up more than 2% through the first quarter of 2021. 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.

Donohue also notes that ARPA provides “welcome breathing room for beleaguered pension sponsors.”

LGIM America estimates that pension funding ratios increased approximately 3.7% throughout March, with the impact primarily due to strong equity performance and higher discount rates. Its Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, shows pension funding ratios increased over the first quarter of 2021 from 82.1% to 90.7% based on market movements.

Equity markets saw persistent gains over the quarter with global equities increasing 4.7% and the S&P 500 increasing 6.2%. Plan discount rates were estimated to have increased by roughly 60 bps in total, while plan assets with a traditional 60/40 asset allocation increased 1.4%. These changes resulted in an 8.6% increase in funding ratio over the first quarter of 2021.

“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 [liability-driven investing] strategy. Adopting a completion framework is one way pension plans can manage uncompensated risk more effectively through volatile market environments,” says Chris Wroblewski, solutions strategist at LGIM America.

NEPC’s Q1 2021 Pension Monitor found the funded status of a total-return plan increased 5.3% for March and 12.7% for the quarter, outperforming the LDI-focused plan, which rose 2.2% last month and 4.3% for the quarter.