DB Plans Fall Victim to the Coronavirus

Defined benefit (DB) plan funded status took a huge hit from a market sell-off because of the novel coronavirus pandemic, according to firms that track it.

Jessica Hart, head of the OCIO [outsourced chief investment officer] Retirement Practice at Northern Trust Asset Management (NTAM), says, “Extreme volatility in both equity and bond markets created big moves in funded ratios as the quarter came to an end. Unprecedented market declines in March led to significant drops in funded ratios during the first quarter from 87.3% to 78.6%. Liabilities were down in March as credit spreads widened, which helped offset some of the decline in equities. Plans with exposure to long government bonds benefitted as those securities returned nearly 21% return during the quarter, providing a tail risk hedge amid the volatility and drawdown.”

According to NTAM, global equity market returns were down approximately 13.5% during the month. The average discount rate increased from 2.30% to 2.74% during the month, which led to lower liabilities.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 3% in March 2020 to 76%, according to Mercer. As of March 31, the estimated aggregate deficit of $576 billion increased by $49 billion compared to $527 billion measured at the end of February.

Mercer notes that the S&P 500 index decreased 12.51% and the MSCI EAFE index decreased 13.82% in March. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased from 2.65% to 3.04%.

Scott Jarboe, a partner in Mercer’s Wealth business, says, “Plan sponsors worried about company cash flow during 2020 have a little extra breathing room as there was a funding relief provision in the recent stimulus bill allowing plan sponsors to delay 2020 contributions until the beginning of 2021. We continue to advocate for longer-term funding relief which could be considered in later stimulus bills.”

The aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies decreased by 2.7 percentage points in March to end the month at 79.2%, according to Wilshire Consulting. The firm says the monthly change in funding resulted from a 7.3% decrease in asset values partially offset by a 4% decrease in liability values. The aggregate funded ratio is estimated to have decreased by 9.4 and 9.5 percentage points during the first quarter and over the trailing 12 months, respectively.

Legal and General Investment Management America (LGIMA) estimates that pension funding ratios decreased only 0.9% to 73.5% throughout March. Its calculations indicate the discount rate’s Treasury component fell by 35 basis points (bps) while the credit component widened 87 basis points, resulting in a net increase of 52 basis points. Overall, liabilities for the average plan decreased approximately 7.2%, while plan assets with a traditional “60/40” asset allocation decreased by approximately 8.3%.

LGIMA says that while no index was spared substantial losses, U.S. large cap stocks outperformed international stocks, falling 12.4% versus 14.1%, respectively. U.S. small cap stocks significantly underperformed both, posting a -21.7% return.

Both model plans October Three tracks lost ground in March: Plan A lost 3% for the month, ending the quarter 13% lower than at the end of 2019, while Plan B slipped more than 1% and is now down more than 4% for the year. 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 with a greater emphasis on corporate and long-duration bonds.

Brian Donohue, partner at October Three Consulting, notes in his March 2020 Pension Finance Update that Treasury rates fell yet another 0.3% in March, ending the quarter a full 1% below the end of 2019. Corporate yields, in contrast, jumped 0.4% as credit spreads widened dramatically last month. As a result, Treasuries gained 4% in March, while corporate bonds lost 5%. In both cases, movements among long duration bonds was the most significant. Overall, bonds were flat to down 3% last month and are now up 3% to 6% for the year, with Treasury portfolios significantly outperforming.

According to River and Mercantile’s Retirement Update for April, considering equity declines, rising credit spreads and Federal Reserve interventions to cut interest rates and provide liquidity, any plan with equity exposure would have seen decreases in funded status for the month. Many plans are seeing funded status losses for the month in excess of 5%, while those with heavy allocations to liability matching assets and better funded status position to start with would have seen less of an effect.

Michael Clark, managing director at River and Mercantile, says, “The effects of market volatility both on equities and interest rates during March will be felt for months, if not years, to come. The big question for many plan sponsors is, ‘What now?’ How a plan sponsor positions itself to take advantage of any recovery in the markets over the remainder of the year will largely determine future costs and contributions. The problem is that no one is sure of when that recovery will occur and how volatile markets will be in the interim. Plan sponsors will want to analyze their approach for dealing with further interest rate risk, especially if there is a wave of defaults in the credit markets, as well as figuring out how to capture market upside when it appears.”

DB Funded Status Also Down for the Quarter

Willis Towers Watson examined pension plan data for 376 Fortune 1000 companies that sponsor U.S. DB plans. Results indicate the aggregate pension funded status is estimated to be 79% as of March 31, compared with 87% at the end of last year. That’s the lowest funded status plans have experienced since 2012, when the year-end funded status stood at 77%.

The analysis found the pension deficit is projected to be $365 billion as of March 31, higher than the $229 billion deficit at the end of last year. Unlike pension assets, pension obligations increased minimally from $1.75 trillion at the end of last year to $1.76 trillion at March 31.

Royce Kosoff, managing director, Retirement, Willis Towers Watson, notes, “Sponsors recently gained some reprieve with funding requirements deferred for 2020 but will likely face significant cost increases in 2021 and beyond. This serves as a fresh reminder for plan sponsors to carefully review their funding policy, investment allocation and overall risk management approach.”

Aon’s Pension Risk Tracker looked at the funded status activity during 2019 for DB plans sponsored by S&P 500 companies in aggregate and found market activity related to the coronavirus is estimated to result in an overall decrease in the funded ratio of 5.6 percentage points from 86.8% to 81.2% in the first quarter of 2020. Treasury rates decreased by 122 bps while credit spreads widened by 127 bps for an overall increase in the discount rate of 5 bps. Aon says this is expected to lead to an increase in the funded ratio during the period of about 2%. In contrast, equity returns of about -21% have driven poor overall asset performance during the first quarter, resulting in an overall return of about -6%. This poor asset performance offset the funded ratio gains achieved by the increase in discount rates.

Aon expanded its estimates to explore the funded status by sector within the S&P 500. Each of the 11 sectors is estimated to have experienced a decrease in the funded ratio of its DB plans during the first quarter. These funded ratio decreases are estimated to range from a decrease of 8.4% to a decrease of 1.1%. Poor equity returns are estimated to result in a significant drag on the funded ratios across all sectors with more pronounced impacts for the sectors with less liability hedging exposure (e.g. health care, utilities) and more muted impacts for sectors with more liability hedging exposure (e.g. consumer discretionary, information technology).

Discount rate increases are estimated to result in a minor offset to the favorable equity return performance. These offsets are estimated to be more pronounced for sectors with lesser liability hedging exposure.

Barrow, Hanley, Mewhinney & Strauss estimated that the average corporate DB plan funded ratio fell to 77.9% as of March 31, from 88.7% as of December 31. Funded status varies significantly by industry. For example, Barrow Hanley says, solvency rules require banks to reduce their reported capital by the amount that pensions are underfunded. Plans sponsored by banks were among the best funded with an average funded ratio of 94.6%. By contrast, airlines have more lenient funding rules than other corporate pension sponsors. They have one of the lowest average funded ratios at just 66.2%.