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Data and Research March 10, 2021
Corporate DB Plan Funded Status Improves to Pre-Pandemic Levels
Equity allocations gave some plans a boost, and experts anticipate new legislation will offer relief from expected higher contributions.
Reported by Rebecca Moore
Corporate defined benefit (DB) plan funded status improved from 86% at the end of January to 88% at the end of February, according to Insight Investment.
“Through February, discount rates have risen approximately 45 bps [basis points], which has caused the liability to drop approximately 5%. Assets have remained level with the losses in fixed income due to rising rates offset by gains in the return-seeking asset portfolio,” says Kevin McLaughlin, Insight’s head of liability risk management.
According to River and Mercantile’s “US Pension Briefing – February 2021,” overall, most pension plans should see their funded status improve for the month, particularly those with higher equity allocations. Pension discount rates continued increasing in February and are up almost 0.5% so far this year, which means lower liabilities for pension plan sponsors. Equity market returns were positive across the board, riding on good COVID-19-related news.
“Pension plan funded status continues to improve in 2021 with rates and equities moving in the right directions for plan sponsors. In addition, the Emergency Pension Plan Relief Act of 2021 [EPPRA] continues to be included in the larger stimulus bill that is making its way through Congress,” says Michael Clark, managing director and consulting actuary with River and Mercantile. “If passed, it will provide many plan sponsors substantial flexibility in deciding how much to contribute to their pension plans in the near future. With pressure taken off cash requirements, it’s likely that we’ll see an increase in allocation to equities to help close any funding gaps for some plan sponsors.”
The average funded ratio of corporate DB plans in the S&P 500 improved in February from 87.9% to 91.3%, according to Northern Trust Asset Management (NTAM). Positive returns in equities along with the increase in discount rates led to the higher funded ratio. Global equity market returns were up approximately 2.3% during the month. Average discount rates increased from 2.32% to 2.61% during the month, leading to lower liabilities.
“Strong equity markets combined with this increase in discount rates have taken average funded ratios to above pre-pandemic levels,” notes Jessica Hart, head of the OCIO [outsourced chief investment officer] retirement practice at NTAM.
Ned McGuire, managing director at Wilshire, also points out that, “February’s liability value decrease was the largest since March 2020 when the markets first reacted to the COVID-19 pandemic.”
Wilshire’s estimate of funded status for S&P 500 companies shows the aggregate funded ratio increased by an estimated 3 percentage points month-over-month in February to end the month at 90.8%. The monthly change in funding resulted from a 4.4 percentage point decrease in liability values partially offset by a 1.1 percentage point decrease in asset values. The aggregate funded ratio is estimated to have increased by 4.0 and 9.2 percentage points year-to-date and over the trailing 12 months, respectively.
According to the Aon Pension Risk Tracker, the aggregate funded ratio for DB plans in the S&P 500 has increased from 91.5% to 95.1%, the highest on record since Aon began tracking the funded ratio for the S&P 500 in 2011. The funded status deficit decreased by $91 billion, which was driven by liability decreases of $138 billion, partially offset by asset decreases of $47 billion year-to-date.
October Three also says pension finance enjoyed its best month in more than three years in February. Both model plans it tracks gained ground last month: Plan A gained 5% and is now up more than 7% for the year, while the more conservative Plan B added 1% and is now up more than 1% through the first two months of 2021. 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 and a greater emphasis on corporate and long-duration bonds.
NEPC’s February 2021 Pension Monitor says that, driven by an increase in Treasury rates and strong equity returns, the funded status of typical corporate pension plans improved in February. It says total-return plans outpaced liability-driven investing (LDI)-focused plans that hedge more interest-rate risk, as losses from fixed-income assets eroded gains from equities. While credit spreads remained mostly flat for the month, the Treasury curve increased and steepened, reducing plan liabilities. Based on NEPC’s hypothetical open- and frozen-pension plans, the funded status of the total-return plan rose 5.2%, while the LDI-focused plan increased 1.9%.
Legal & General Investment Management (LGIM) America estimates that pension funding ratios increased approximately 3.5% throughout February, with the impact primarily due to strong equity performance and higher liability discount rates, according to its Pension Solutions’ Monitor. Its calculations indicate the discount rate’s Treasury component increased 38 bps while the credit component tightened 8 bps, resulting in a net increase of 30 bps. Overall, liabilities for the average plan decreased 3.2%, while plan assets with a traditional 60/40 asset allocation rose approximately 0.8%.
Several firms noted that President Joe Biden’s $1.9 trillion stimulus package would extend DB plan funding relief, saving plans from increases in required contributions. Brian Donohue, a partner at October Three Consulting, says, “This legislation will be crucial to pension decisionmaking in the months ahead.”