Administration January 11, 2021

Strong End to 2020 Puts DB Plan Funded Status Back to Where It Started the Year

Defined benefit plans that use an LDI strategy faced less volatility over the year, and funded status improvements were helped by gains in risk assets.

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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.

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“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.

Compliance January 11, 2021

Supreme Court Appeal Filed in Wells Fargo Stock-Drop Case

The appeal asks whether an earlier Supreme Court ruling means ESOP fiduciaries are effectively immune from duty-of-prudence liability for the failure to publicly disclose potentially damaging inside information.

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The plaintiffs in a long-running Employee Retirement Income Security Act (ERISA) lawsuit filed against various Wells Fargo defendants have petitioned the U.S. Supreme Court to review an unfavorable ruling handed down by the 8th U.S. Circuit Court of Appeals in July.

The 8th Circuit ruling at issue affirmed a lower court ruling out of the U.S. District Court for the District of Minnesota, which sided firmly with the Wells Fargo defendants based on precedent set by the 2014 Supreme Court ruling known as Fifth Third v. Dudenhoeffer.

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The allegations in the suit follow the classic pattern of so-called “stock-drop” litigation. Such suits are often filed when a negative news story or regulatory filing reveals a piece of information that causes the price of a company’s stock to decline—leading to losses in the retirement investment accounts of its employees. In this case, negative media reports and congressional inquiries plagued Wells Fargo’s personal banking wing for several years, starting in late summer 2016. According to contemporaneous news reports and the admissions of now-ousted CEO and Chairman John Stumpf, the company’s aggressive sales requirements for low-level banking professionals directly inspired the opening of millions of unauthorized customer accounts.

Disclosure of this information resulted in a significant backlash against the company. At its low point, Wells Fargo’s stock lost roughly 12% to 15% of its pre-disclosure value, while the company faced separate civil penalties approaching $200 million.

In their petition, the plaintiffs/appellees call on the Supreme Court to answer two primary questions:

  • Whether, under Dudenhoeffer, employee stock ownership plan (ESOP) fiduciaries are effectively immune from duty-of-prudence-liability for the failure to publicly disclose inside information; and
  • Whether Dudenhoeffer’s framework extends beyond prudence-based claims and applies to duty-of-loyalty claims against ESOP fiduciaries.

In Dudenhoeffer, the Supreme Court held that stating a claim against fiduciaries of an ESOP, for breaching ERISA’s duty of prudence in the offering of their own company’s stock, requires meeting a high pleading standard, given the fact that rigorous securities disclosure laws are almost always implicated. Specifically, the ruling requires that plaintiffs plausibly describe “an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.”

Dudenhoeffer also held that such a claim is governed by ordinary pleading standards and requires a “careful, context-sensitive scrutiny” of whether the complaint plausibly alleges that fiduciaries “behaved imprudently by failing to act on the basis of nonpublic information that was available to them because they were [company] insiders.”

The plaintiffs’ Supreme Court appeal suggests that various courts of appeal have adopted impermissibly divergent interpretations of Dudenhoeffer. Most of them, according to the plaintiffs, are overly strict and make the successful filing of stock-drop lawsuits nearly impossible.

“Last term, this court granted certiorari in Retirement Plans Committee of IBM v. Jander to clarify what it takes to plausibly allege a breach, but vehicle problems prevented it from doing so,” the appeal states. “Meanwhile, the [8th Circuit] has deepened the split, and interpreted Dudenhoeffer to effectively immunize all ESOP fiduciaries from duty-of-prudence claims premised on the failure to publicly disclose inside information because such disclosure would always cause an initial stock drop.”

The appeal, which stretches over 30 pages, presents various detailed arguments to this effect.

“In Dudenhoeffer, this court made clear that ERISA applies its stringent duty-of-prudence standards to all ERISA fiduciaries, including ESOP fiduciaries, except where the statute provides otherwise,” the appeal states. “Accordingly, the Supreme Court rejected the application of any pleading presumption to ESOP fiduciaries, disapproving an approach that made it impossible to state a duty-of-prudence claim. Yet, the 8th Circuit does just this. It requires plaintiffs to satisfy hurdles that are so onerous that it is difficult to imagine how a plaintiff could ever successfully plead a claim for relief.”

The argument continues as follows: “According to the 8th Circuit, plaintiffs are flatly barred from relying on generally applicable economic principles that any prudent fiduciary would be required to consider. So, they are deprived of the very context-specific circumstances that Dudenhoeffer identified as necessary for explaining how or why a prudent fiduciary should have known to take alternative actions such as earlier corrective disclosure. It will be similarly difficult to overcome inferences favoring fiduciary delay—the 8th Circuit’s presumption of prudence in the face of any ongoing investigation all but shuts the door on any earlier-disclosure claim, even when such a claim could proceed under the securities laws.”

Among other supporting arguments, the plaintiffs invite the Supreme Court to compare how claims filed on behalf of the ESOP stack up against those filed by outside investors in the wake of the fake-account scandal.

“Left to stand, the 8th Circuit’s decision erects a pleading rule that incongruously treats ERISA participants and beneficiaries less favorably than private investors,” the appeal states. “Recall that those non-ERISA investors brought securities-fraud and state-law fiduciary-duty claims against Wells Fargo and its insiders for the same misconduct that formed the basis of the plaintiffs’ duty-of-prudence claims here. And recall also that those claims were all subject to pleading standards that are indisputably higher than they are supposed to be here. But, unlike here, when courts had the opportunity to examine those claims, they had little difficulty concluding that those plaintiffs stated claims for relief—even under those heightened pleading standards. That was true with regard not only to claims that Wells Fargo executives breached the securities laws by failing to make an early corrective disclosure, but also to claims that they violated state-law fiduciary obligations—which are considered possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”

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