Now It Is About Protecting Healthy Funded Levels

Higher interest rates since 2022 have put corporate pension funds at their highest funding levels in many years, prompting plan sponsors to consider options to hold onto the gains and limit their risk.

Corporate defined benefit pension plan sponsors have a singular opportunity to evaluate if their plans are in a position to offload liabilities using pension risk transfer or allocate to strategies with less risk, including liability-driven investing, reviewing their options to best provide pension benefits to the participants to whom they were promised at the lowest cost for the company going forward.

Separate Milliman and Principal Asset Management research on pension plan funding finds sponsors have room to now accelerate de-risking—as the funded status of many has improved to reach fully funded and near-to-fully funded status—to protect funding levels.

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The funded status of the average U.S. corporate pension plan “sits around [the] 105% level, so it’s over funded,” explains Owais Rana, head of investment solutions at Principal Asset Management.

“It is therefore an opportune time for pension plan sponsors to take risk off the table, particularly the investment risks to begin with, and then start considering whether it makes sense to further de-risk their balance sheets by embarking on a pension risk transfer strategy or maintaining the obligations on their balance sheets, also known as hibernation by de-risking their investment strategy.”

State of PRT Market

The U.S. pension risk market was estimated to have $14.6 billion, in the first quarter of 2024 compared to the previous Q1 record of $6.3 billion in 2023 and nearly triple the 2022 figure of $5.3 billion, finds a Legal & General Retirement America May 2024 market update.

The pension risk transfer market is expected to remain strong, according to Cerulli Associates research.  

“Over the last handful of years, we’ve seen pretty historic pension risk transfer activity, and across the board, [survey respondents] felt like it was going to continue, regardless of where interest rates have gone,” says Chris Swansey, associate director, institutional, at Cerulli Associates.

More than two-thirds of plan sponsors (69%) said they are at least somewhat likely to de-risk over the next 24 months, found Cerulli in research conducted in the second quarter of 2023, published in May. 

“Over the last handful of years, we’ve seen pretty historic pension risk transfer activity, and across the board, everybody felt like it was going to continue, regardless of where interest rates have gone,” adds Swansey. “Funded statuses have improved dramatically, and a lot of plan sponsors are looking at fully funded or surplus funding. So that kind of creates an opportunity … we’ve also had a number of new entrants into the insurance space, and that’s driven down costs.”

Pension Funded Status Research

In 2023, three of the top 100 U.S. pensions reached a funded ratio greater than 140%; one achieved between 135% to 140%; and two plans each were within funding ratios of 130% to 135%, 125% to 130% and 120% to 125%, according to Milliman research.

Almost 50, nearly half of the companies within the Milliman data set reached fully funded levels, explains Zorast Wadia, principal and consulting actuary at Milliman.

“[It] only improved in the first four months of 2024,” he says. “So, I would think that now more than half of the largest U.S. plan sponsors are at or above full funding levels.” 

In total, 69 plans are between 95% and above 140%, finds the Milliman 2024 Corporate Pension Funding Study. The study tracks public companies with the largest DB pension plan assets for which a 2023 annual report was released by March 10, 2024.

“[It’s] an important place to be for pensions because we haven’t seen these types of funding levels for a decade and a half,” explains Wadia, co-author of the study. 

In 2023, the average funded ratio of the 100 pension plans tracked by Milliman decreased slightly to 98.5% from 99.4% at the end of 2022 and the 7.2% investment return was not enough to pace the growth

“A deficit of $19.9 billion this year put corporate DB plans of the Milliman 100 companies within striking distance of achieving full funding,” Milliman researchers wrote.

In 2023, the pension deficit of the Milliman 100 companies rose to $19.9 billion from $8.5 billion, Milliman reported.

For sponsors, with healthy funded levels the focus often shifts to measures to protect funding, says Wadia.

“The whole emphasis of [corporate DB sponsors] should be right now to make sure to lock in these gains: You don’t want history to repeat itself, like in the late [19]90s [when] pension plans were in a great position,” but did not protect the gains, he says.

Corporate pension funds should learn from past mistakes, Wadia adds.

Timing

Rana and Sri Reddy, senior vice president of retirement and income solutions at Principal Financial Group, say the timing is right for corporate DB sponsors by swapping out equity-like exposure for fixed income assets, Rana wrote in a post online, earlier this year.

“What I ask CFOs and CEOs is, ‘What is the relative size of your pension obligations relative to your current earnings?’” says Reddy.  “That’s a good proxy” for the risk the pension funding declining could add to a business.

The de-risking strategies available to sponsors include lump sum payments, particularly to participants who are near retirement; and full or partial pension risk transfers, according to Rana. 

“From my perspective, [de-risking in ways we recommended] would allow plan sponsors who have been waiting for this point to sleep well at night,” explains Rana.

For sponsors, following Principal Asset Management’s recommendation to de-risk would almost entirely “defease most of their investment risks relative to liabilities,” he adds.   

With the blueprint, “[plans] haven’t eliminated [the investment risk]—[because] the only way to do that is with a pension risk transfer, but they have defeased a significant amount of risk out of the system and now the companies can concentrate on their actual business as opposed to spending ,” Rana says.  

Wadia agrees that de-risking portfolios will require exploring reallocating plan assets to lower-risk assets and liability-driven investment strategies. 

“LDI is the strategy that makes sense if you want to sleep well at night, if you’d want to minimize interest rate risk and investment return risk,” he says.

Learning their lessons from the past, sponsors do not want to surrender healthy funded level gains, Wadia adds.

“[LDI] is essential as your funding status improves, you want to move away from risky investments, i.e., equities and go into fixed income,” he explains.

Using LDI, sponsors allocate to fixed income portfolios, “matching your liability payout stream—your [plan’s] unique payout stream—to your plan.”

Plans with full funding or that are close to fully funded, de-risking to lock-in gains will address, Rana adds.

“[Sponsors] need to seriously start to match the interest rate risk of the liability and sell some of that equity risk to reduce the overall mismatch between assets and liabilities,” says Rana.

He clarifies that while the Federal Reserve may start to cut interest rates this year, that would have little effect because “short-term rates will have very little to no direct impact on liability valuations,” adds Rana.

Factors to Consider

Corporate sponsors, protecting healthy funded levels, should base their decisions to de-risk, reallocate or offload liabilities on the overall health of their plan, says Rana.

“[There is] no one factor … there are a few factors, which are … going to be very unique and specific to each plan sponsor,” he explains.

Open plans that are accruing benefits require a distinct strategy from a closed plan, for example, explains Wadia.

“Do you still have a highly leveraged final average pay plan design that many would consider a dinosaur plan? These plans have very aggressive accrual patterns, and are highly leveraged, so participants entering later years of service—the benefits can really move off the charts and so with the newer types of plan designs like cash-balance plan designs, and variable-annuity plans, there’s a deeper level of risk sharing between the plan participant and the sponsor.”

The interest rate sensitivity of a plan’s liabilities is also an important factor to consider, adds Rana.

The longer-dated obligations are the more sensitive the assets are going to be to interest rates, Rana says, “hence, [sponsors] must explore the LDI component far more than an obligation that’s going to be of a two-year duration, for instance [because] the interest rate risk [of the asset] is not that much.”

Another factor, “and one of the most important ones,” is the strength of the company and its ability to withstand bad market events, says Rana.  

Declining equity markets and lower “long-end” interest rates will affect sponsors, flipping sponsor’s funded status toward a less healthy position, he adds.

“Are companies in a position to bear that risk, which translates into future contributions that they will have to make into these plans? A lot of the companies that have defined benefit pension plans have been industrial companies. If you look at the universe of those companies that have the strength to withstand these events, [it] is going to be very low, which means that they are better off de-risking … as opposed to being to be forced to divert capital away from shareholders into a pension plan in the future,” Rana says.

Retaining Skilled Experts Requires Employer Flexibility

Implementing a phased approach to retirement and transitioning workers in a ‘flex-tirement’ paradigm helps employers to remain competitive and keep down hiring costs.
Employers are keeping their skilled experts on staff, preparing for massive turnover and the loss or transfer of institutional knowledge with innovative approaches, reflecting significant demographic changes.

Employers are tackling retention challenges in part by providing employees with a transition approach to retirement that involves employees continuing to contribute to their retirement plan, continuing employees’ health insurance until age 65, enabling flexible and hybrid work schedules, and cross-training employees in certain, distinct roles.

In 2024, the U.S. population entered the first Peak 65 year when more than 11,000 Baby Boomers will turn 65 every day, finds the Peak 65 Economic Impact Study from the Alliance for Lifetime Income.

“Many companies are nervous about a lot of traditional knowledge and experience walking out the door in large volumes,” explains Heather Tinsley-Fix, senior adviser, employer engagement at AARP. “Between 2024 and 2027, [more than 4 million] Baby Boomers turn 65 each year, and that’s a typical common age for retirement, so I think companies are nervous about just the volume of people leaving.”

Totaling about 11 million, the older workforce has almost quadrupled in size since the mid-1980s, found research by the Pew Research Center, published in 2023. Adults ages 65 and older are projected to be 8.6% of the labor force in 2032, up from 6.6% in 2022; and older adults are projected to account for 57% of labor force growth over the period.

Employers have developed focused strategies to retain older workers.

“The best way to leverage older workers is to continue to employ them, to give them flexible options to stay with you, and to develop age-inclusive policies and practices, like providing support for working family caregivers, providing health and financial benefits, making sure that you have learning and development opportunities that apply to everybody [and] making sure that older workers are treated the same as everyone else,” explains Tinsley-Fix.

Sponsors, as employers, must tackle their own challenges with regards to recruiting, hiring and training personnel to work in human resources and benefits. For employers, regarding sponsor-specific roles in HR and across positions, generally there is an “acknowledgement that because the workforce is graying in such large numbers because there are fewer babies being born to enter the labor force,” says Tinsley-Fix. Companies are realizing “that they need to have these kinds of talent management strategies and a very deliberate offboarding process and approach as well as a process to welcome people back in, like return-ships and things like that. So, they know it’s important.”

Employers Preparing


A 2023 study by business management consultant Bain & Company finds 25% of the workforce will be over 55 by 2031; representing a near 10% increase from 2011; and approximately 150 million jobs will be done by older employees, the data shows.

For employers, remaining competitive requires retaining the institutional knowledge of older workers because hiring is costly, explains Frances Brown, director of retirement and policy at Lumen Technologies, Inc.

“We’re always preparing for that, cross training and having people move roles or rotate through roles,” says Brown.

The Monroe, Louisiana- based telecommunications company taps specific techniques, “making sure there’s always a backup or somebody that knows the same [skills] as somebody else—that’s been our philosophy and how we manage,” the graying of the workforce.

For employers, retaining their institutional knowledge is vital, explains Brown.

With Lumen’s approach, “you [are able to] keep that knowledge, and then transition it,” adds Brown. “Hiring someone take can take months to do, so if we can do this and find somebody who will take over that position—you don’t have that [employment] gap. For Lumen, there’s costs in hiring, versus somebody remaining in that role, so it helps us.”

In 2020, U.S. Census Bureau data found the 65-and-older population grew by more than one-third (34.2%) or 13,787,044 in the 10 years between 2010 and 2020, by 3.2% (1,688,924) from 2018 to 2019 and the population increase has contributed to a rise in the national median age from 37.2 years in 2010 to 38.4 in 2019, according to the Census Bureau’s 2019 Population Estimates.

“For employers, they’ve got to figure out flexible ways to retain their older workforce, and some of them are not set up to do that,” adds Tinsley-Fix. “There’s lots of different ways that companies can flexibly retain those folks.”

Retaining With Benefits


Bolstering employee benefits is another method employers are using to prepare.

In 2023, Delta Air Lines launched an emergency savings program.

Delta does not “necessarily go out and tout the emergency savings program over other aspects of our employee [benefits] program, but I do think it’s an incredible retention tool, and not just because Delta provides this program and gets a $1,000 bonus into it,” explains Josh Jessup, general manager of global retirement and financial wellness at Delta Air Lines.

“It’s a piece of the puzzle,” to both retain older workers and attract new hires of all ages, he adds.

The “most common” method employers have used is have employees “work fewer days per week,” adds Tinsley-Fix. “You can work four days a week or three days a week and you’ll have a commensurate drop in pay, but you’ll keep some key benefits.”

Lumen employees can work flexible schedules, says Brown.

On Brown’s team, for example, “some [employees] work four days a week and some work three to four-and-a-half days a week, and then their hours are flexible,” she says.

“[It] allows for people to have a little bit more balance in their life and do other things that they want to do,” explains Brown.

Supporting their employees’ work-life balance is helping Lumen to establish a culture that “has really been good to keep people around,” she adds. “It’s this thing that’s not any kind of monetary benefit, but it’s more of a work-life balance benefit that people love.”

Key benefits employers may utilize include:

  • Flexible work hours
  • Hybrid work programs
  • Arrangements to phase into retirement over one year
  • Providing practical mentorships to retain older workers
  • Upskilling
  • Offering in-retirement-plan protected retirement income options and annuity products
  • Offering employees the option to retain their health coverage until age 65; and
  • Providing family leave policies for parents and grandparents.

Tinsley-Fix notes, “being able to retain health coverage,” is important, at least until age 65.

“After 65 when you do qualify for Medicare, then it becomes a little less important but in that crucial 10-year period [from] 55 to 65 it’s really, really important for companies if they’re offering phased retirement to include health coverage in that and to dictate if it’s [available to people working] 20 hours or 30 hours, whatever the threshold is that you need to maintain to keep those benefits [is key],” she explains.

In addition to parental leave, emerging employee benefits include grand-ternity leave, explains Cyrus Bamji, chief strategy and communications officer at the Alliance for Lifetime Income.

“Caregiving is such a big issue, for everybody out there, especially women,” he says. “Cisco [Systems] for example, I know, gives three days … of paid time off for a [new] grandparent.”

Retirement plan sponsors should also offer their participants “protected income and annuity solutions,” he adds. “There’s no doubt there’s data to show that, number one, employees need it and want it in their plans.”

With the employer’s organization the domain of the retirement and other benefits of the plan sponsors could be empowered to a greater degree, he adds.

“HR departments very often don’t even have as much decision-making and control these days on these types of things,” he says. “They’re made by committees at a higher level and or at the CFO level, which I get, and I understand for liability reasons and so on and so forth, but I think it all just kind of snowballs to—rather than looking at what’s best for our employees, what products, what services, what benefits are best—these folks, so many of them are just there to execute on a benefit versus actually develop strategies long-term. The appreciation for your HR departments and the skills that some of those folks have just needs to improve. You need to be able to trust some of those folks more.”

Flex-tirement?


Pursuing a flexible approach to retirement will require employers to amend their plans and other benefits. Keeping their skilled experts may require employers to allow workers to remain enrolled in the retirement savings program and continue to make retirement contributions as well, explains Neil Costa, founder and CEO of HireClix, a digital recruitment marketing firm based in Gloucester, Massachusetts.

“Not everybody [wants to draw down assets], if they’re still interested in working, they’re not ready to withdraw, from the retirement plan, and I think they may even have more discretionary income to put away into retirement,” Costa says.

“Many companies focus their flexible retirement options, targeting them towards the employees who have the most specialized skills or who have a ton of experience,” adds Tinsley-Fix. “In sales, for example, or in legal or compliance departments, there’s a lot of focus on those people who have a deep base of knowledge, and they don’t want to lose that knowledge or that skill set.”

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