The funded status of the nation’s largest corporate pension plans started and finished last year at the same level, as declining interest rates caused pension obligations to grow, offsetting gains from investments in equities and bonds, according to an analysis by Willis Towers Watson.
Willis Towers Watson examined pension plan data for 366 Fortune 1000 companies that sponsor U.S. defined benefit (DB) plans and have a December fiscal-year-end date. Results indicate that the aggregate pension funded status is estimated to be 87% at the end of 2020, unchanged from 87% at the end of 2019. The analysis also found the pension deficit is projected to be $233 billion at the end of 2020, slightly higher than the $230 billion deficit at the end of 2019.
In its U.S. pension briefing for December, River and Mercantile notes that global equities posted a solid month to close out the year, up anywhere from 4% to 8%, with small cap and international developed markets seeing the largest gains. For 2020 as a whole, U.S. equity markets ended the year up 15% to 19%, with international equities posting high single digit returns.
According to River and Mercantile, pension discount rates were basically flat during December, up only 0.02% during the month, leaving the total discount rate decline relative to year-end 2019 at approximately 0.70%.
The firm says plans with significant U.S. equity exposure will likely finish off 2020 in a better position than they began.“December proved to be a good month for pension plan sponsors with discount rates remaining flat and positive equity returns translating into funded status gains for most plans. Going into 2021 many plan sponsors will be hoping to see the 2020 trend of declining discount rates reverse course,” says Michael Clark, managing director at River and Mercantile. “With all the forces at play in the current economic environment, it’s difficult to see how rates will move back to 2018 and 2019 levels in 2021. We expect some movement in discount rates with the improvement in economic activity, but not back to the levels 3.5% to 4.0% from a few years back, at least for the for the first half of 2021.”
The aggregate funded ratio for U.S. corporate pension plans increased by 1.7 percentage points month-over-month in December to end the month at 86.8%, a 0.3 percentage point decrease from December 2019, according to Wilshire Associates.
“Over the calendar year, the funded ratio saw heightened volatility dropping more than 7 percentage points during the first quarter with a near full recovery over the final three quarters” says Ned McGuire, managing director, Wilshire Associates.
Wilshire says December’s funded ratio resulted from a 1.5 percentage point increase in asset values and a 0.3 percentage point decrease in liability values. Over the year, there was a 10 percentage point increase in liability, mostly offset by a 9.5 percentage point increase in asset values.
The average funded ratio of corporate pension plans improved in December to 86.4% from 84.5%, according to Northern Trust Asset Management (NTAM) data. Global equity market returns were up approximately 4.6% during the month. The average discount rate increased from 2.08% to 2.1% during the month, which led to lower liabilities.
“Despite a tumultuous year in equities and rates, the average funded ratio is now back to where it was at the beginning of the year. It is noteworthy, however, that discount rates are still down 74 basis points [bps] from the end of 2019. The market rally over the last several months has been the main driver for the recovery in the funded ratio,” says Jessica Hart, head of the OCIO [Outsourced Chief Investment Officer] Retirement Practice at NTAM.
Barrow, Hanley, Mewhinney & Strauss LLC has estimated that corporate pension plan funded ratio increased to 89.1% as of December 31, from 84% as of September 30. Continuing the trend since Q1 2020, strong equity market performance more than offset pension liability increases.
Jeff Passmore, liability-driven investing (LDI) strategist says, “The fact that funded status ended 2020 at 89.1%, roughly where it began the year, is ironic. In fact, average funded status fell to 72.7% as of March 23, and has improved each quarter-end since. Pensions that have implemented LDI experienced less volatility. Those that have not implemented LDI had larger swings.”
Legal & General Investment Management America (LGIMA) estimates that pension funding ratios increased approximately 2.3 percentage points throughout December, with the impact primarily due to the strong equity performance outpacing plan liabilities. Its calculations indicate the discount rate’s Treasury component increased 7 bps while the credit component tightened 6 bps, resulting in a net increase of 1 bp, according to the LGIMA Pension Solutions’ Monitor. Overall, liabilities for the average plan remained relatively flat, while plan assets with a traditional 60/40 asset allocation rose approximately 2.9%.
LGIMA’s Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, found that pension funding ratios increased over the fourth quarter of last year. It estimates the average funding ratio increased from 77.9% to 82.1% over the quarter based on market movements.
Equity markets saw a strong rally over the quarter, with global equities increasing 14.8% and the S&P 500 increasing 12.2%. Plan discount rates were estimated to have fallen by 17 bps in total. Treasury rates rose 20 bps on average while A-AAA credit spreads tightened 37 bps over the quarter. Overall, plan assets with a traditional 60/40 asset allocation increased 9.1%, resulting in a 4.2% increase in funding ratios over the fourth quarter of 2020.
“The fourth quarter capped off a year of extraordinary market volatility with investors experiencing a dramatic downturn, quickly followed by an impressive recovery in asset prices,” says Chris Wroblewski, solutions strategist at LGIMA. “Volatile times like this show 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. The adoption of a more tailored fixed income allocation through a completion framework can help protect funded status drawdowns and complement a plan’s de-risking glide path given unexpected market volatility.”
“December gave us one more turn of the screw from extraordinary 2020 stock markets, pushing pension sponsors into the black for the year,” says Brian Donohue, a partner at October Three Consulting, in his December 2020 Pension Finance Update. Both model plans October Three tracks gained ground last month, with Plan A adding 3% and Plan B gaining 1% during the month. Plan A ended the year with close to a 2% gain, while Plan B managed a 1% gain during 2020. 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.
“Pension funding relief has reduced required plan funding since 2012, but, under current law, liabilities will increase substantially over the next three years,” Donohue says. “Plans that have only made required contributions in the past can expect significant increases in required contributions over the next couple years.”
He adds that the rebound in pension finances since March has reduced the likelihood of additional pension funding relief legislation. “There is some chance we get more relief in 2021, but the recovery we have seen this year may make that less likely,” Donohue says.
S&P 500 aggregate pension funded status increased in the month of December from 89.3% to 91.3%, according to Aon’s Pension Risk Tracker. This is the first time the tracker showed a result over 90% since its inception in 2011.
Pension asset returns were positive during the month, ending December with a 2% return. The month-end 10-year Treasury rate increased by 9 bps relative to the November month-end rate, and credit spreads narrowed by 5 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.25% to 2.29%. Given that a majority of the plans in the U.S. are still exposed to interest rate risk, the decrease in pension liability caused by increasing interest rates slightly compounded the positive effect of asset returns on the funded status of the plan.
During 2020, the aggregate funded ratio for U.S. pension plans in the S&P 500 has increased from 86.8% to 91.3%, Aon finds. The funded status deficit decreased by $87 billion, which was driven by asset increases of $210 billion, offset by liability increases of $123 billion year-to-date.
NEPC’s tracking of two hypothetical pension plans found that for the fourth quarter, the funded status of a total-return plan increased by 5.9%, outperforming an LDI-focused plan, which rose by 5.4%. The funded status of the total-return plan improved as risk assets gained in the quarter, and the LDI-focused plan saw a positive return in funded status from gains in risk assets, according to NEPC’s Pension Funded Status Monitor. The plan is 81% hedged as of December 31.
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