December Tops a Stellar Year for Corporate DB Plans

Discount rates and equity returns both moved in the right direction for U.S. corporate defined benefit (DB) plan sponsors to end 2021, which should have resulted in improved funded status over the month, River and Mercantile says in its “US pension briefing – December 2021.” It adds that many plan sponsors should see a noticeable improvement to their year-end funded status compared with the beginning of the year.

Due to higher stock markets and higher interest rates, both model plans October Three tracks gained ground last month. Plan A improved almost 2% in December, ending the year up 11%, while the more conservative Plan B gained less than 1% last month, ending the year up 3%. 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.

“Overall, 2021 was the best year for pensions since 2013 and the second-best year this century,” says Brian Donohue, a partner at October Three Consulting in Chicago.

The average funded ratio of DB plans in the S&P 500 improved in December from 93.8% to 95.9%, according to Northern Trust Asset Management (NTAM). Global equity market returns were up approximately 4% during the month, and the average discount rate increased from 2.42% to 2.51% during the month, leading to lower liabilities.

According to Insight Investment, DB plan funded status improved by 2.1% from 93.4% to 95.6% during December. Assets increased by 1.2%, and liabilities declined by 1%.

Q4 Funding Improvement

LGIM America estimates the average funded ratio of a typical corporate DB plan rose from 89.7% to 92.6% over the fourth quarter of 2021.

Its Pension Fiscal Fitness Monitor says equity markets experienced a strong quarter, with global equities rising 6.8% and the S&P 500 increasing 11%. Further, plan discount rates were relatively unchanged over the quarter as credit spreads were estimated to have widened 9 basis points (bps), offsetting a roughly 9 bps drop in the Treasury component. Assets in plans with a traditional 60/40 asset allocation increased 4.1%.

Barrow Hanley Global Investors estimates that the average corporate pension plan funded ratio increased to 100% as of December 31, from 97.1% as of September 30. It says asset gains drove the improvement. Barrow Hanley estimates the funded ratios of corporate pension plans sponsored by companies in the Russell 3000.

Scott McDonald, long-duration portfolio manager and co-head of fixed income at Barrow Hanley, says, “The strong equity market in 2021 drove pension funded status higher and on average corporate pensions are fully funded.”

Funded status varies significantly by industry, according to the Barrow Hanley analysis. The highest average funded status by industry is banks at 119.2%. Airlines, with more lenient funding rules, have one of the lowest average funded ratios at 87.4%.

Looking Ahead

Looking to the future, the markets could face more ups and downs in 2022.

“As the market faces more uncertainty with COVID-19, U.S. fiscal policy and inflation, the potential for further volatility is heightened,” says Chris Wroblewski, solutions strategist at LGIM America. “Decoupling risks that can have an impact on a pension plan’s funded status, such as interest rate and credit spread risk, can be beneficial, while allowing plan sponsors to implement a more appropriate LDI [liability-driven investing] strategy. Adopting a completion framework is one way pension plans can manage uncompensated risk more effectively through volatile market environments.”

River and Mercantile forecasts a cautiously optimistic year ahead.

“Assuming that the economy continues to move forward despite the ongoing pandemic and that supply chains and unemployment rates continue to improve, pension plan sponsors may be in for a pleasant year with increasing discount rates and positive equity returns,” River and Mercantile says. “There is a lot that could throw a wrench into the optimistic forecast, but for pension plan sponsors, we’re currently looking at what could very well indeed play out to be another decent year.”

Similarly, NTAM says it’s anticipating growth ahead.

“For 2022, our base case outlook focuses on slowing but sustainable growth, along with resilient corporate profits,” says Jessica Hart, head of OCIO [outsourced chief investment officer] retirement practice at NTAM. “The history of central bank tightening cycle shows that positive equity and fixed-income returns can be realized in steady, well-telegraphed tightening cycles—the scenario we expect in 2022.”

Finally, given the past year’s growth, plan sponsors should make sure to protect their gains.

“Our model shows that funded status improved by more than 7% over fiscal year 2021, driven by increases in discount rates as well as strong returns by equities and other growth assets during the year,” says Sweta Vaidya, North American head of solution design at Insight Investment. “The first order of business should be to protect these funded status gains (either by reducing interest rate risk, equity risk or both) in order to reduce future volatility and increase the likelihood of achieving end-state objectives for the pension plan.”