Rebounding Markets Give DB Plan Funded Status a Boost in October

“Pension plans will generally see their funded status improve as higher liabilities are offset by stronger equity returns,” River and Mercantile says in its “US Pension Briefing – October 2021.”

Michael Clark, managing director in River and Mercantile’s Denver office, explains that the yield curve began to flatten out in October with the short end of the curve increasing and the long end coming down. He says this is an indication of the market view that the Federal Reserve will begin raising interest rates in 2022, along with an expectation that recent increases in inflation will subside.

“What should pension plan sponsors look at with year-end in sight?” Clark asks. “Continue to watch market expectations on timing of the Fed rate increases, which will be affected primarily by unemployment, wage growth and the persistence of inflation relative to expectations. These will be the key drivers of where discount rates end up on December 31.”

Insight Investment says defined benefit (DB) plan funded status improved 1.5 percentage points to 94.6% in October. Assets increased by 2.3% and liabilities increased by 0.6%. “As the end of the fiscal year approaches for many plan sponsors, we may see this increase in funded status spur more discussions on de-risking and end-state objectives,” says Sweta Vaidya, North American head of solution design at Insight Investment.

The aggregate funded ratio for U.S. corporate DB plans sponsored by S&P 500 companies increased by an estimated 1.1 percentage points month-over-month in October to end the month at 94%, according to Wilshire.

The monthly change in funding resulted from a 2.3% increase in asset values partially offset by a 1% increase in liability values. The aggregate funded ratio is estimated to have increased by 6.2 and 11.3 percentage points year-to-date and over the trailing 12 months, respectively.

“October’s funded ratio increase nearly reversed all of September’s decline, driven by the monthly increase in nearly all asset classes led by U.S. equities,” says Ned McGuire, managing director, Wilshire.

According to Northern Trust Asset Management (NTAM), the average funded ratios for S&P 500 plans improved in October from 93.8% to 95.2%. Global equity market returns were up approximately 5.1% during the month. The average discount rate decreased from 2.56% to 2.46% during the month, leading to higher liabilities.

Funded Status Improvement by Plan Stage

Industry estimates show differences in funded status improvements based on a DB plan’s lifecycle and investments.

LGIM America estimates that pension funding ratios overall increased approximately 2% throughout October, primarily due to robust global equity performance. According to its October “Pension Solutions Monitor,” the firm’s calculations indicate the discount rate’s Treasury component declined 4 basis points (bps) while the credit component was relatively unchanged, resulting in a net decrease of 4 bps. Overall, liabilities for the average plan increased 0.8%, while plan assets with a traditional 60/40 asset allocation rose by approximately 3.1%.

In its “Pension Monitor,” NEPC says total-return plans with larger equity allocations and more intermediate-duration fixed income likely experienced a smaller improvement in funded status relative to liability-driven investing (LDI)-focused peers that hold longer-duration assets. Based on NEPC’s hypothetical open- and frozen-pension plans, the funded status of the total-return plan increased 1.5%, while the LDI-focused plan improved 2.5% last month.

“October provided a positive environment for pensions sponsors, as both equity markets and long-duration fixed income had positive returns. All investors should consider rebalancing as a risk management tool,” NEPC says. “With rates showing more volatility, plan sponsors should track their plan’s funded status to maintain desired hedge ratios and monitor LDI glide path triggers. NEPC maintains its recommendation to adhere to plan hedge ratios and long-term strategic target allocations.”

Both model plans October Three tracks improved last month. Plan A gained 2% in October and is now ahead more than 11% for the year, while the more conservative Plan B gained 1% last month and is now 3% up through the first 10 months of 2021. 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.

Brian Donohue, a partner at October Three Consulting in Chicago, notes that pension funding relief was signed into law during March. “The new law substantially relaxes funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors,” he says.