August Emerges as the Best Month for DB Plan Funded Status in 2020

Positive returns in the equity market, along with higher discount rates, led to higher funded ratios for corporate defined benefit (DB) plans, according to the majority of firms that track DB plan funded status.

The aggregate funded ratio for U.S. corporate pension plans in the S&P 500 increased by 4.4 percentage points in August to end the month at 84.7%, according to Wilshire Associates. This increase was the result of a 4.6 percentage point decrease in liability values and a 0.5 percentage point increase in asset values. However, the aggregate funded ratio is estimated to have decreased by 2.4 percentage points year-to-date and 1.3 percentage points over the trailing 12 months, primarily due to rising liability values.

“August’s increase in funded ratio was primarily driven by the decrease in liability values as corporate bond yields used to value corporate pension liabilities increased by over 20 basis points [bps],” says Ned McGuire, managing director and a member of the Investment Management & Research Group at Wilshire Consulting. “August’s increase in funded ratio was also driven by the best August performance for the Wilshire 5000 since 1984, which helped propel the funded ratio to the largest increase since February 2015 and second largest increase since 2013.”

According to Mercer, the estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased by 4 percentage points in August to 83%. As of August 31, the estimated aggregate deficit of $433 billion decreased by $124 billion compared with $557 billion measured at the end of July.

The S&P 500 index increased 7.01% and the MSCI EAFE index increased 4.98% in August, Mercer says. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased from 2.2% to 2.46%.

“With yield levels so low and U.S. equity markets near all-time highs, a key issue is how best to optimize portfolios to continue generating excess returns. Volatility may continue through and beyond the U.S. elections, so plan sponsors may want to revisit their investment policies to ensure they are aligned with their risk tolerance,” says Matt McDaniel, a partner in Mercer’s Wealth business.

The Northern Trust Asset Management August pension fund report notes that the average funded ratio of corporate DB plans improved significantly from 79.1% to 83.5%. Global equity market returns were up approximately 6.1%, while lower liabilities resulted from an increase in the average discount rate from 1.94% to 2.23%.

According to Jessica Hart, head of the OCIO [outsourced chief investment officer] Retirement Practice at Northern Trust Asset Management, “While the average funded ratio is just 3 percentage points away from fully recovering year-end levels, plan sponsors that opted to defer contributions may be further away from their end of 2019 starting point. The CARES [Coronavirus Aid, Relief and Economic Recovery] Act permitted plan sponsors to defer any required quarterly contributions until next year. For these pension plans, maintaining the return seeking allocation may help improve funded ratio over time while being aware of the commensurate risks with this approach.”

Though August has been the best month, so far, for pension plan funded status with both discount rates and equity markets moving higher, Michael Clark, managing director at River and Mercantile, warns, “There is still cause for caution going into the last four months of the year. Equity markets are almost sure to be volatile with any pandemic-related news as well as the upcoming U.S. election.”

River and Mercantile’s Monthly Retirement Update notes that many plans will have a lower funding level than at the start of the year due to falling discount rates, which are down more than 0.5% below year-end levels.

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios increased approximately 5.6% throughout August. Its calculations indicate the discount rate’s Treasury component increased 24 bps while the credit component widened 4 bps, resulting in a net increase of 28 bps. LGIMA’s Pension Solutions’ Monitor says that, overall, liabilities for the average plan decreased approximately 4%, while assets for plans with a traditional “60/40” asset allocation increased by approximately 3.4%.

October Three’s model Plan A saw the highest funded status increase in August, at 6%. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation. Its model Plan B, a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds, had a funded status gain of 1%, according to its Pension Finance Update.

Aon’s Pension Risk Tracker shows the aggregate S&P 500 pension funded status in August increased from 84.7% to 87.5%. Pension asset returns equaled 1% for the month. The month-end 10-year Treasury rate increased 17 bps relative to the July month-end rate and credit spreads widened by 5 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.12% to 2.34%.

However, Aon says that during 2020, the aggregate funded ratio for U.S. pension plans in the S&P 500 has increased from 86.8% to 87.5%. The funded status deficit increased by $1 billion, which was driven by liability increases of $122 billion, partially offset by asset increases of $121 billion year-to-date.