U.S. Corporate Pension Funding Remains Largely Unchanged in January

A lower discount rate and higher equity returns left funding levels in January similar to where they finished the year in 2022. Analysis firms disagreed in some respects, however, as some found that corporate pensions posted negative month-to-month results in January, while others found positive month-to-month results.

Pension funding improved modestly in January, as higher stock markets more than offset the impact of lower interest rates, according to October Three’s pension finance update.

Each model allocation at the firm finished the month up 1% in funding status. The firm’s traditional 60/40 portfolio gained 6%, on its assets during January, while the conservative 20/80 portfolio added more than 4% to its assets.

The gain was based on the strong month stocks enjoyed across the board in January, as a diversified stock portfolio gained more than 8% over the month. Additionally, interest rates fell and credit spreads narrowed; treasury yields declined 0.3%, while corporate bond yields fell 0.4% during January. As a result, bonds gained between 4% and 7% last month, with long-duration bonds performing best.

Discount rates effectively moved 0.4% lower last month, and October Three expects that most pension sponsors will use an effective discount rate in a range between 4.6% and 4.9% to measure pension liabilities.

Aon, in its pension risk tracker, found that the aggregate funded ratio for U.S. pension plans in the S&P 500 had increased from 93.6% to 94.3%, in January. Pension asset returns were up significantly throughout January, ending the month with a 5.3% return. The month-end 10-yr Treasury rate decreased 36 basis points relative to the December 2022 month-end rate, and credit spreads remained constant.

This combination resulted in a decrease in the interest rates used to value pension liabilities, from 4.68% to 4.32%. Given a majority of the plans in the U.S. are still exposed to interest-rate risk, the increase in pension liability caused by decreasing interest rates partially offset the positive effect of asset returns on the funded status of the plan.

According to estimates from Insight Investments, the average funded status improved by 0.4%—from 102.1% to 102.5%—in January. The average discount rate fell by 38 bps, from 5.11% in December 2022 to 4.74% in January; the change in rates is mostly due to the change in the risk-free rate. Insight Investments data pegged assets in the portfolio increasing by 4.9% and liabilities increasing by 4.4% during January.

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 in January,  to 99.8% from 98.3%.

“Equity markets rallied through the month with global equities and the S&P 500 gaining 7.2% and 6.3%, respectively. Plan discount rates were estimated to have decreased roughly 47 basis points over the month with the Treasury component decreasing 37 basis points and the credit component tightening 10 basis points,” the pension solutions monitor stated in its report. “Given broad-based asset allocation shifts from the market these last few years, we’ve adjusted the standard pension portfolio from a 60/40 equities/credit allocation to a 50/50 asset allocation. Plan assets with our recalibrated traditional “50/50” asset allocation increased 6.9% while liabilities increased by only by 5.3%, resulting in a 1.5% increase in funding ratios by January month-end. Strong equity performance overcame increases in plan liabilities, resulting in an increase in the average funding ratio.”

Wilshire’s U.S. Corporate pension funded status estimates concluded that U.S. corporate pension plans increased by an estimated 1.3 percentage points month-over-month, ending the month at 98.8%. The monthly change in funded ratio resulted from Wilshire’s projections that portfolios experienced a 5.6% increase in asset values, offset by a 4.1% increase in liability values. Wilshire estimated that funded statuses have increased by 2.9% over the trailing 12 months.

Milliman, in its latest Milliman 100 Pension Funding Index, found that ratios fell from 110% to 109.3% during January. The drop was due to a 37-bps decline in the monthly discount rate, from 5.22% in December 2022 to 4.85% at the end of January. As a result, the PFI projected benefit obligation rose to $1.387 trillion at the end of January, from $1.331 trillion at the end of December 2022. This outpaced investment gains of 3.97%, which lifted the market value of plan assets by $51 billion.

Looking forward, under an optimistic forecast—with rising interest rates (reaching 5.40% by the end of 2023 and 6.00% by the end of 2024) and asset gains (9.9% annual returns)—the funded ratio would climb to 122% by the end of 2023 and 138% by the end of 2024. Under a pessimistic forecast—a 4.30% discount rate at the end of 2023 and 3.70% by the end of 2024, with 1.9% annual returns—the funded ratio would decline to 100% by the end of 2023 and 91% by the end of 2024.

According to insights from Agilis’ January 2023 U.S. pension briefing, shared plan funded statuses were likely little-changed for many plans, though systems that have a significant weighting towards equities saw their funding statuses improve, because equity markets were up 7% to 8%, and their discount rates fall, with the FTSE Pension Liability Index down about 0.33%.

“As we point out, 2023 has had a decent start for pension plan sponsors with a well-diversified portfolio. Even though discount rates pulled back and liability values increased as the long end of the yield curve came down and investment grade credit spreads narrowed, equity markets increased. Optimism that inflation has peaked, and that the Fed would start to slow down its rate increases pushed equity markets higher and long-term interest rates lower,” Agilis managing director Michael Clark said in a statement. “All eyes are on the Fed as it is expected to continue increasing interest rates in 2023 to try to slow down inflation and the overall economy and to do so as a soft landing. Despite headline layoffs, the January jobs report surprised many with how strong job growth was and unemployment fell to its lowest levels since the 1960s. This good news has investors fearing the Fed may need to raise rates further than expected and is fueling fears of recession.”

WTW, in its’ pension finance watch, saw its WTW Pension Index decrease in January to 100.0, reflecting a decrease in funding status of 1.3% for the period; an increase in liabilities, due to a decrease in discount rates, was partially offset by strong investment returns.

Yields on long high-quality corporate bond indices decreased an average of 38 bps. These moves were followed by decreases in long Treasury rates, with yields on 10- and 30-year Treasury bonds decreasing by 36 and 32 bps, respectively. The fixed-income investments of the benchmark portfolio had a positive return at 2.7%, with Long Treasury Bonds and Long Corporate Bonds experiencing the largest gain.