Funding Status of Pensions Increases Marginally Despite Equity Market Downturn

Rising rates in September contributed to higher overall funded ratio for corporate pension funds. Equities continued their year-long slump with the Nasdaq trading down over 10% and S&P 500 trading down 9.6% on the month.

The dynamic led to at least two pension consultants finding that U.S. corporate pension funding levels moved above 100% in September as an increase in the discount rate more than offset the month’s asset losses.

The Milliman 100 Pension Funding Index funded ratio climbed to 109.2% as of September 30 from 106.3% on August 31, the highest ratio of the year. The stems from a large 75-basis point increase in the monthly discount rate. The PFI projected benefit obligation fell by $118 billion as the discount rate rose to 5.36% for September from 4.61% in August—the highest rate since June 2011. This increase helped to offset September’s investment losses of 5.24%, which lowered the Milliman 100 PFI asset value by $87 billion.

“September’s massive increase in the discount rate had quite the upward effect on the PFI funded ratio,” said Zorast Wadia, principal and consulting actuary at Milliman and coauthor of the PFI. “This jump more than negated September’s asset losses, which were the worst of the year to date.”

Insight Investment’s data shows that corporate pension funded status improved by 1.4 percentage point, reaching to 100.4% during September from 99.0% in August. Assets decreased by 7.8% and liabilities decreased by 9.1%

The average discount rate rose by 75bp from 4.51% in August to 5.26% in September, Insight reported.

According to Aon’s Pension Risk tracker, the month-end 10-year Treasury rate increased 68 bps relative to the August month-end rate and credit spreads widened by 6 bps. This combination resulted in an increase in the interest rates used to value pension liabilities to 4.97% from 4.23%. The report noted that majority of plans in the U.S. are still exposed to interest rate risk, though the decrease in pension liability caused by increasing interest rates partially offset the negative effect of asset returns on the funded status of plans.

Pension liabilities decreased as interest rates were up significantly across the quarter. Ten-year Treasury rates were up 85 bps over the quarter and credit spreads narrowed by 22 bps, resulting in a 63-bps increase in the discount rate over the quarter for an average pension plan. During 2022, the aggregate funded ratio for U.S. corporate pension plans in the S&P 500 has decreased from 95.5% to 93.9%, according to the Aon Pension Risk Tracker. S&P 500 aggregate pension funded status increased during the month of September to 93.9% from 93.0%. The tracker found that pension asset returns were down significantly throughout September, ending the month with a negative 6.8% return.

MetLife Investment Management, in its third quarter U.S. corporate pension funded status report, found that the average funded ratio rose to 100.7% as of September 30, 2022, up from 98.5% at the end of the second quarter. Further findings from the report conclude that the average third quarter 2022 asset return for U.S. corporate pension plans was negative 6.9%. At the same time, pension liabilities fell by 10.3% due to higher discount rates, offsetting the drop in asset losses.

According to LGIM America’s Pension Solutions Monitor U.S. pension funding ratios were unchanged through September. The monitor which tracks U.S. corporate defined benefit pension plans, reported that the average funding ratio is estimated to have started and ended the month at 95.6%. Plan discount rates were estimated to have increased roughly 83 bps over the month with the Treasury component increasing 61 bps and the credit component widening 22 bps. Plan assets with a traditional “60/40” asset allocation decreased 7.5%; however, the fall in liabilities due to rising rates resulted in no change in funding ratios by September month-end.

In October Three’s monthly Pension Finance Update, model plans were found to have lost around 100 basis points in the month, due to the slump in equities and valuations. Brian Donohue, author of the update, wrote, “between interest rates reaching levels not seen since 2011 and stocks suffering their worst year since 2008, pension finances have actually been pretty stable this year. Pension balance sheets have shrunk around 20% on both the asset and liability side, but overall funded status has held up pretty well.”

The update shares that a diversified stock portfolio lost more than 9% in September and is now down 26% so far during 2022, and that the traditional “60/40” portfolio lost 7% during September and is now down 22% for the year, while the conservative “20/80” portfolio lost 6% last month and is also down 21% through the first three quarters of 2022.

NTAM’s third-quarter pension funded status report, states that the average funded ration increased during this period, ending at 98.5%, up from 96.3% in the previous quarter. “The average funded ratio has improved year-to-date and during the third quarter, despite market volatility. Risk assets continued to suffer with global central banks tightening more aggressively due to unprecedented inflation being the primary headwind. As long-duration bonds continue to incur losses from higher yields, pension liabilities have been declining. The declining asset and liability values have also resulted in lower dollar amounts of the pension deficit. Thus, cash contributions have a bigger impact than before in terms of improving the plan’s funded ratio, ” wrote Jim Hayes, head of the OCIO retirement practice at Northern Trust Asset Management.

According to the WTW Pension Finance Watch, the equity portion of the benchmark portfolio returned negative 9.3% in September, with all equity asset classes incurring similar declines. The fixed income investments of the tracked benchmark portfolio also had a negative return at negative 3.8%. The report found the performance of a hypothetical pension plan invested in a “60/40” portfolio recorded a negative 7.1% return for the month. Portfolios with 20% and 60% fixed income allocations produced negative 8.2% and negative 6.0% returns, respectively.

Discount rates used by U.S. plan sponsors to measure pension obligations are typically measured with reference to yields on high quality corporate bonds. Pension obligations move in the opposite direction of the interest rates used for their valuation. The liability implicit in the index decreased by 7.2% from the discount rate change and the accumulation of interest.

Agilis Managing Director Michael Clark, shared the following:

“Pension discount rates are now at levels that we haven’t seen since back in 2011. …Even with investment returns posting their worst month of 2022, many plan sponsors may be surprised to see their funded status remain relatively unchanged with the commensurate decline in liabilities.”