Data and Research December 14, 2022

Corporate Pension Plan Funding Remains Up in 2022, Despite November Drop

The funding status of corporate pensions in the U.S. was down narrowly in November, as liability growth outweighed investment gains.

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For the month of November, pension funding statuses declined by 1.4 percentage points from 105.5% to 104.1%, while assets increased by 5.1% and liabilities increased by 6.5%, according to Insight Investment. During the month, the average discount rate fell by 55 basis points to 5.05% in November from 5.61% in October. The change in rates is primarily due to the change in the risk-free rate, while spreads decreased considerably during the month.

“Year-to-date funded status has still improved by more than 7%, driven primarily by pension discount rates having risen by ~200 bps over the year,” said Sweta Vaidya, head of solution design at Insight Investment. “The Fed has indicated that it will begin slowing down on rate hikes, but that we may expect rates and inflation to persist higher for longer than originally anticipated.”

LGIM America’s Pension Solutions Monitor, which estimates the health of a typical U.S. corporate defined benefit pension plan, estimates that pension funding ratios decreased from 100.7% to 100.2% through November.

Equity markets had a strong month, with global equities and the S&P 500 rising 7.8% and 5.6%, respectively. Plan discount rates were estimated to have decreased roughly 62 basis points over the month, while the Treasury component decreased 43 basis points and the credit component tightened 19 basis points.

Overall, plans with a traditional “60/40” asset allocation increased 6.1%, and liabilities rose by 6.7%.

According to October Three’s November monthly pension update, pension finances were mixed in November, as lower interest rates offset the impact of higher stock prices.

According to October Three’s data, interest rates, which have risen steadily all year, fell in November, pushing up bond returns. Treasury yields fell 0.4% last month, and corporate bond yields declined 0.5%. As a result, bonds gained 4% to 7% in November but remain down 13% to 24% for the year, with long-duration and corporate bonds performing worst. October Three expects most pension sponsors will use effective discount rates in the 5.0% to 5.2% range to measure pension liabilities at the end of 2022.

Corporate bond yields fell 0.5% during November but remain up 2.3% this year. As a result, pension liabilities rose 5% to 8% last month but are still down 16% to 27% for the year.

Stocks advanced strongly and broadly during November. A diversified stock portfolio gained 7% last month but is still down more than 15% in 2022. With one month to go, 2022 is looking like a surprisingly positive year for pension finances, particularly in view of double-digit stock market declines.

November legislation provided additional relief for pension, expanding upon a pension funding relief law signed in March 2021.

“The new laws substantially relax funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors. However, the surge in interest rates this year, if sustained, will reduce or eliminate the impact of funding relief,” wrote Brian Donohue, a partner at October Three.

During the month, the Milliman 100 Pension Funding Index funded ratio declined from 113.3% in October to 111.2%. The drop was due to the monthly discount rate decreasing to 5.16% from 5.71%. As a result, the PFI projected benefit obligation rose to $1.342 trillion, representing a loss of $76 billion for the month, even as investment gains of 4.63% caused the market value of assets to rise by $59 billion.

“November’s discount rate decrease was the largest monthly drop of the year and only the second monthly decline we’ve seen in 2022,” said Zorast Wadia of Milliman, co-author of the PFI. “This caused the plans’ funded status to drop, despite November’s stellar investment returns, which were the largest monthly gain of the year.”

Wilshire’s U.S. Corporate Funded Status for the month of November found that the aggregate funded ratio for U.S. corporate pension plans was unchanged from October, ending the month at 99.1%.

The month’s activity in funded ratios resulted primarily from a 6.3% increase in liability values, offset by a 6.4% increase in asset values. The aggregate funded ratio is estimated to have increased by 2.9% year-to-date and 5.5% over the previous 12 months.

According to the WTW Pension Finance Watch, the equity portion of the benchmark portfolio returned 6.3% in November, with the international equity asset class having the largest growth. Yields on long high-quality corporate bond indices decreased an average of 56 basis points, and the yield reductions were followed by decreases in long Treasury rates. The yields on 10- and 30-year Treasury bonds decreased 42 basis points over the month.

The WTW Pension Index tracks the performance of a hypothetical pension plan invested in a portfolio with 60% invested in equity and 40% in fixed income. This portfolio recorded a 5.1% return for the month.

Pension obligations move in the opposite direction of the interest rates used for their valuation. The liability implicit in the index increased by 7.2% from the discount rate change and the accumulation of interest. These factors contributed to an overall decrease of 1.9% in the WTW Pension Index, which closes the month at 103.4%.

“Everything continues to be about interest rates,” proclaims Agilis’s U.S. pension briefing for November, “funded status at the end of the month will be close to where it started, despite the big changes in discount rates and investment returns.”

Agilis highlights that the Treasury yield curve continues to be inverted, a potential indicator of a looming recession. The lower discount rate meant higher liabilities for pensions offsetting market gains; leaving pension plan funded ratios at, or slightly lower on the month.

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Pension plan sponsors are still better off today than they were at the start of the year which could have a meaningful effect on year-end balance sheets into the end of 2022.

Compliance December 14, 2022

Democrat Support for SEC’s Scope 3 Climate Disclosure Weakens

Compliance costs for Scope 3 climate disclosures could be high, but they don’t apply to everyone.

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House Democrats signaled their skepticism of Scope 3 climate risk disclosure in a hearing held by the Investor Protection, Entrepreneurship and Capital Markets Subcommittee of the House Committee on Financial Services last week.

In March, the Securities and Exchange Commission proposed a rule that would require public companies to disclose information about their “climate-related risks that are reasonably likely to have a material impact on their business.” The proposal would require public companies to disclose information about their own direct greenhouse gas emissions, indirect emissions produced as a result of the companies’ electricity consumption and emissions generated its supply chain. These dimensions are referred to as Scope 1, Scope 2 and Scope 3 disclosures, respectively. This rule has not been finalized.

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At the December 8 hearing, Subcommittee Chairman Brad Sherman, D-California, said, “Scope 1 and Scope 2 being proposed by the SEC, I think, make a lot of sense. It is going to be hard to go into Scope 3, and that may be a bridge too far; it may give us effects far beyond what we are trying to achieve.”

Sherman is far from alone in this opinion. A letter by Representative Cynthia Axne, D-Iowa, signed by four other House Democrats in October, also expressed concern about Scope 3. In particular, the letter called for clarity and greater protections for farms and small businesses that would have to collect data for their publicly listed customers and suppliers.

Democratic opposition to the Scope 3 provision in the SEC proposal is important because Republican lawmakers have been targeting this provision for months as part of their general opposition to the SEC effort. Weakening Democratic support for Scope 3 could make it more likely that the provision will be dropped from any final rule.

The Scope 3 provision is particularly controversial because it would require private businesses that are not registered with the SEC to collect data on their emissions so that they can provide it to public companies, which could be a tedious and expensive process. Scope 3 is very important for climate risk data collection, however, because for many businesses the majority of their emissions come from their suppliers.

Opposition to the Scope 3 proposal is especially acute for small businesses since they argue they are less able to bear the compliance costs of the proposal. The Small Business Investor Alliance is also concerned that many public firms will feel obligated to report Scope 3 emissions, even if the proposal does not actually apply to them. In comments filed to the SEC, the organization wrote, “As other commenters have pointed out, the materiality ‘threshold’ used in the Proposal is amorphous, and most companies will likely feel obligated to report Scope 3 information.”

Professor Shivaram Rajgopal of Columbia University noted during his testimony to the subcommittee hearing that a publicly listed pizza company would likely have to collect emissions data from independent delivery drivers in order to be compliant with Scope 3. Rajgopal was invited to testify by the House Democrats, who constitute a majority of the subcommittee.

Some of this concern over Scope 3 may be overestimated, however. The SEC’s proposal allows for “reasonable estimates” of Scope 3 emissions, provided the registrant discloses the assumptions behind their estimate, obviating the need for precise measurements, while also reducing the value of the data produced.

The Scope 3 provision also only applies to registrants that have an emissions goal or for which Scope 3 emissions are a material factor for their investors. Registered funds, for example, would only need to collect Scope 3 data if environmental factors are significant in investment selection or the fund is trying to achieve a specific environmental impact, the SEC said.

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