Administration April 12, 2017

DB Plan Funded Status Moving in the Right Direction

Several analyses show funded status improvement for the month of March as well as the first quarter.
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The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased by 1% to 83% in March, as an increase in discount rates was partially offset by mixed equity markets, according to Mercer. As of March 31, 2017, the estimated aggregate deficit of $391 billion represents a decrease of $9 billion as compared to the deficit measured at the end of February. The aggregate deficit is down $17 billion from the $408 billion measured at the end of 2016.

The S&P 500 index remained nearly level and the MSCI EAFE index gained 2.3% in March. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased by 8 basis points to 4.01%.

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“Plan sponsors should consider re-evaluating their risk appetites in these uncertain times. Despite the Federal Reserve’s indications that short term rates may steadily increase in the near future, there is still quite a bit of uncertainty on what will happen with long-term rates and equity markets, which are two main factors that affect the funded status of pension plans, says Jim Ritchie, a partner in Mercer’s wealth business. “Those plan sponsors that are relying on long-term rates to rapidly rise in the near future may continue to be frustrated with the lack of progress on their funded status. Plan sponsors should look at multiple future economic conditions to get a good perspective on the future financial condition of their pension plans.”

Wilshire Consulting also estimates a nearly 1% increase in corporate pension plans’ funding status in March.

The aggregate funded ratio for U.S. corporate pension plans increased by 0.9 percentage points to end the month of March at 83.9%, up more than 6 percentage points over the trailing twelve months, according to Wilshire.

The monthly change in funding resulted from a 0.9% decrease in liability values while asset values remained relatively flat. For the quarter, the aggregate funded ratio is up 2.0 percentage points from 81.9% at the end of 2016.

“March marked the seventh consecutive month of rising or flat funded ratios, which has contributed to March month-end funded ratios being the highest since October 2015,” says Ned McGuire, vice president and a member of the Pension Risk Solutions Group of Wilshire Consulting. “This month’s increase was primarily driven by the decrease in liability values caused by the 9 basis points rise in corporate bond yields used to value pension liabilities.”

NEXT: Funded status for Q1 rises

The aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 80.9% to 82.1% year-to-date, according the Aon Hewitt Pension Risk Tracker. 

The funded status deficit decreased by $22 billion, which was driven by asset growth of $35 billion and offset by a liability increase of $13 billion year-to-date. Pension liabilities increased by 0.6% as rates declined. Ten-year Treasury rates were down by 5 bps over the quarter and credit spreads narrowed by 1 bp, resulting in a 6 bps decrease in the discount rate over the quarter for an average pension plan.

Aon Hewitt notes that return-seeking assets were prosperous during the first quarter, with the Russell 3000 Index returning 5.7%. Equities outperformed bonds during the quarter, with the Barclay’s Long Gov/Credit Index returning 1.6% over this timeframe. Overall pension assets returned 3.3% over the quarter.

Meanwhile, according to Legal & General Investment Management America’s (LGIMA) Pension Fiscal Fitness Monitor, the pension funding ratio of a typical U.S. corporate defined benefit (DB) plan rose from 81.3% to 83.9% over the quarter.

The Pension Fiscal Fitness Monitor showed funded ratios increased over the quarter as assets grew more than pension liabilities. Global equity markets increased by 7.05% and the S&P 500 increased 6.07%. Plan discount rates fell 1 basis point, as Treasury rates decreased 4 basis points and credit spreads widened 3 basis points.

Overall liabilities for the average plan rose 1.27%, while plan assets with a traditional “60/40” asset allocation increased 4.53%, resulting in a funding ratio increase of 2.61%.

LGIMA’s Head of Solutions Strategy, Don Andrews, says, “We estimate that funded ratio levels for the typical plan with a traditional asset allocation increased primarily due to assets outperforming the liabilities. Equity markets experienced a strong rally and fixed income assets remained relatively stable, with liability values increasing slightly. This contributed positively to the funded ratio.”

He adds, “We are seeing renewed interest in hedging interest rate risk from many plan sponsors looking to lock in these funding ratio gains after benefiting from a large gain in equities. In particular, plan sponsors are considering customized LDI strategies such as liability benchmarking, completion management and option-based hedging strategies.”

Investing April 12, 2017

Considering Annuities As Insurance

Roberta Rafaloff, with MetLife, says plan sponsors should stop discussing annuities as if they are investments.
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Roberta Rafaloff, vice president, institutional income annuities, MetLife, clearly spends a lot of time in the complex world of retirement income planning products.

She recently told PLANSPONSOR her 29-year career at MetLife has been dominated by annuities design and “thinking about the transition to retirement income from defined contribution (DC) and defined benefit (DB) plans.”

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“In the last three decades we have seen a real evolution in how retirement income planning has been looked at and thought about,” she suggested. “If you look at the prevalent reasons why people aren’t accessing income in the DC planning context, in particular, you see some participants who say they like to maintain control of their money, and others who say they will have separate sources of lifetime income. But there is also a significant group who thinks they can achieve better investment outcomes in the end if they manage the money on their own rather than annuitizing.”

Rafaloff called this last statement “extremely problematic” from her point of view. 

“Income annuities are not investments and they really should not be compared to an investment, because in a lot of participants’ eyes the comparison won’t be favorable,” she said. “Income annuities are more properly considered as insurance—insurance that guarantees an individual will not run out of money no matter how long they live. That is an entirely different idea from, say, buying a mutual fund to attempt to increase your net wealth over time.”

Rafaloff went on to observe that many who fail to purchase any lifetime income when they have the option to do so later end up regretting their choices. They are paralyzed at the time by the unfortunate possibility that they could die earlier than expected—perceived as the main risk of annuities as investments. But once investors think about annuities more in the vain of insurance, comfort can increase dramatically. 

NEXT: Giving up the pot of gold isn’t easy

“If you think about it, when people look at their defined contribution plan at the point of retirement, they tend to look at it as that proverbial pot of gold. Nobody really gets excited about taking that pot of gold and turning it into a sustainable paycheck,” Rafaloff said. “Taking that lump sum can be tempting; it’s probably going to be more money than the individual has had access to ever before in the past. But for so many people the better course of action is going to be at least considering partial annuitization.”

Of course, for some people it may make sense to take large cash distributions to pay down credit card debt or housing debt.

“But our data clearly shows a lot of people actually take their DC plan money and don’t do anything productive with it, either spending it on a major discretionary purchase or even giving it away in a significant number of cases,” she warned. “It speaks to the personal responsibility ethic that really needs to be driving successful DC plan outcomes. We all think it would be great to be able to give some of your wealth away when you die, but if you’re going to become a burden on other people or on the government later in life because you preferred not to buy annuities, that’s not something most people are going to want to experience, either.”

Again, this is the sense in which annuities should be discussed in a way that is different from DC plan investments, Rafaloff concluded. 

“The other thing people should think about is, how well will [participants] be able to manage those assets as [they] grow older and older? Even if [they] are financially savvy now in [their] 50s and 60s, [they] may want to consider carefully how [their] cognitive ability to manage those assets and make optimal decisions may shift over time. I know it might be hard for people to want to think about, but they really do need to consider this. There are many research reports showing most people do suffer material cognitive decline as they age. And so building an insured, stable income plan at the point of retirement or, better yet, in advance of retirement—that’s going to drive the best outcomes for most people.”

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