Markets Push Pension Funded Status Higher in 2017

Although defined benefit (DB) plans had mild to flat funded status improvements near the end of 2017, overall it was a good year.

December

According to Aon Hewitt, which tracks daily funded status movements for DB plans of S&P 500 companies, aggregate pension funded status decreased in the month of December from 82.4% to 81.7%. Pension asset returns remained positive during the month of December, ending with a 1.2% return. However, the month-end 10-yr Treasury rate increased by 1 basis point (bp) relative to the November month-end rate while credit spreads narrowed by 15 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 3.49% to 3.35%. Given a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates counteracted the positive effects from asset returns on the funded status of the sample plan.

For the same reasons, P-Solve says DB plans’ pension funded status took a small hit in December. October Three notes that its traditional Plan A lost 1% in December, and the more conservative Plan B dropped a fraction of 1% last month. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

The aggregate funded ratio for U.S. corporate pension plans decreased by 0.4 percentage points to end the month of December at 85.4%, according to Wilshire Consulting. The monthly change in funding resulted from a 1.6% increase in liability values partially offset by a 1.1% increase in asset values.  “December ended three consecutive month of increases in funded ratios and is only the fourth month of funded ratio declines for the year,” says Ned McGuire, managing director and a member of the Pension Risk Solutions Group of Wilshire Consulting. 

Q4 2017

Legal & General Investment Management America’s (LGIMA) Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, shows pension funding ratios remained flat over the fourth quarter of 2017. Global equity markets increased by 5.84% and the S&P 500 increased 6.64%. However, this was offset by plan discount rates falling 17 bps, as Treasury rates decreased by 7 bps and credit spreads tightened by 10 bps. Overall, liabilities for the average plan rose 3.47%, while plan assets with a traditional “60/40” asset allocation increased 3.39%, keeping funding ratios flat over the fourth quarter of 2017.

According to Aon Hewitt, pension liabilities increased by 2.4% as rates fell. Ten-year Treasury rates were up by 10 bps over the quarter and credit spreads narrowed by 32 bps, resulting in a 22 bps decrease in the discount rate over the quarter. Return-seeking assets were positive during the fourth quarter, with the Russell 3000 Index returning 6.3%. Equities outperformed bonds during the quarter, with the Barclay’s Long Gov/Credit Index returning 2.8% over this timeframe. Overall pension assets returned 3.5% over the quarter.

Barrow, Hanley, Mewhinney & Strauss, LLC (Barrow Hanley), a value-oriented investment manager, estimated that corporate pension plan funded ratio rose to 87.1% as of December 31, 2017, from 85.4% as of September 30. It estimates that pension assets had a 3.6% return for the fourth quarter of the year while liabilities were only up 1.5%. However, the firm notes that funded status varies significantly by industry.

Barrow Hanley explains that solvency rules require banks to reduce their reported capital by the amount that pensions are underfunded. So, plans sponsored by banks were among the best-funded with an average funded status of 104.9%. By contrast, Airlines, have more lenient funding rules than other corporate pension sponsors, so they have the lowest average funded status with an average funded ratio of just 69.5%.

Funded status improved over the year

Barrow Hanley has estimated the funded status of corporate pension plans sponsored by companies in the Russell 3000 using information disclosed in SEC Form 10-K and returns for asset class indices for each year-end since 2005. At December 31, 2017, the average funded status for these plans was 87.1%, up from 81.3% at year-end 2016, according to the firm.

LGIMA estimates the average funding ratio ended the year at 84.1%. “We estimate funded ratio levels have increased by around 3% over 2017, driven by strong equity markets which have helped assets outperform the liability return over the year,” said Ciaran Carr, solutions strategist at LGIMA.

According to Aon Hewitt, during 2017, the aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 80.9% to 81.7%. The funded status deficit increased by $9 billion. This change was driven by asset growth of $135 billion offset by a liability increase of $144 billion.

DB plan funded status was up 4.5 percentage points over the trailing twelve months, according to Wilshire Consulting. October Three’s traditional Plan A ended the year more than 3% ahead, while Plan B ended 2017 up more than 1%.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies as of December 31, 2017, increased to 84% from 82% as of December 31, 2016, according to Mercer. Over the course of 2017, increases in equity and fixed income markets more than offset decreases in interest rates used to calculate corporate pension plan liabilities to support the increase in funded status, the firm said. The estimated aggregate deficit of $375 billion as of December 31, 2017 is $33 billion less than the $408 billion deficit at the end of 2016.

According to Northern Trust Asset Management, S&P 500 U.S. corporate pension plans’ average funded ratio increased from 80.0% at the end of 2016 to 82.9% at the end of 2017 as broadly positive asset returns more than compensated for a sharp decline in discount rates. The increase in funded ratio was driven by two primary factors: Asset returns were strong as global equity markets returned approximately 24% during the year; and the average discount rate decreased sharply from 4.00% to 3.53% during the month. During the year the liabilities increased by approximately 10.5% on average, primarily driven by lower discount rates.

Northern Trust observed that the estimated deficit for pension plans of the S&P 500 corporations has declined from $407 billion at January 1, to $372 billion at December 31. Plan sponsors that adopted liability-driven investment (LDI) strategies experienced larger funded ratio gains relative to those in core fixed income.

Buoyed by strong market returns and larger-than-expected employer contributions, the funded status of the nation’s largest corporate pension plans improved modestly at the end of 2017 compared with the end of 2016, according to an analysis by Willis Towers Watson. The analysis examined pension plan data for the 389 Fortune 1000 companies that sponsor U.S. defined benefit pension plans and have a December fiscal-year-end date. Results indicate that the aggregate pension funded status is estimated to be 83% at the end of 2017, compared with 81% at the end of 2016. The analysis also found that the pension deficit is projected to have decreased to $292 billion at the end of 2017, compared with a $317 billion deficit at the end of 2016.

“Strong stock market performance throughout the year and robust employer contributions to their pension plans helped to boost funded status to its highest level since 2013 after several stagnant years,” said Matthew Siegel, a senior consultant at Willis Towers Watson. “Several plan sponsors contributed more to their plans last year than originally expected, most likely in response to rising Pension Benefit Guaranty Corporation premiums and growing interest in de-risking strategies, and potentially in anticipation of lower future corporate rates from tax reform. The improved funded position occurred even though pension discount rates finished the year down approximately 50 basis points from the beginning of the year.”