Rising Discount Rates Continue Pension Funding Improvement

The 2023 market rally that strengthened the pension funded status for most U.S. corporate defined benefit pension plan sponsors has continued into 2024. According to several pension trackers, the funded status of the plans continued to rise in January.

The WTW Pension Index, which tracks the performance and funded status of a hypothetical 60/40 plan, rose to 108.8 in January, up 1.2% from the closing figures from 2023.

WTW attributed this performance primarily to a rise in discount rates, supplemented by investment returns. The 60/40 tracked portfolio returned 0.4% in January. Liabilities increased to negative 0.8% during the month, resulting in a 1.2% change in the index.

WTW also tracks several other hypothetical pension portfolios. According to the index, portfolios with 20% and 60% allocations to fixed income returned 0.6% and 0.2%, respectively. A 60/40 portfolio with an emphasis on longer-duration fixed income lost 0.5%.

Milliman

The funded status of corporate U.S. pension plans increased by 1 percentage point to 103.1% during the month of January, according to the Milliman 100 Pension Funding Index, which tracks the finances of the largest 100 U.S. corporate pension plans.

The increase was driven by an increase in discount rates, which rose 14 basis points to 5.14% in January. Plan liabilities decreased as a result, to 1.316 trillion at the end of January from $1.337 trillion at the end of December. This outweighed asset losses of 0.30%, dropping asset totals to $1.356 trillion.

“After significant declines in discount rates in the fourth quarter of 2023, January saw some upward rate movement, which led to a modest improvement in the funding surplus,” said Zorast Wadia, a principal in Milliman and the report’s author, in a statement. “But with expectations of rate cuts later this year, we could see plan sponsors shifting allocations further to fixed income to better match anticipated rises in pension liabilities.”

Funded status for pension plans within the S&P 500 increased 0.9% to 101.8% in January, according to Aon’s pension risk tracker, which tracks the financial health of pensions within the S&P 500 Index.

The 0.9% increase in funded status represents an increase of $14 billion across all tracked plans. Liabilities decreased $29 billion, offset partially by a $15 billion decrease in the value of plan assets, which lost 0.4% for the month.

According to Aon, the increase in interest rates to the range of 4.96% to 5.12% resulted in a decrease in the value of plan liabilities, which offset declines in asset values. The 10-year Treasury rate increased 11 basis points relative to the end of December, which, combined with a 5-bps-credit-spread widening resulted in an increase in the interest rates used to value pension liabilities.

LGIM America

Not every tracker found funded status to have increased in January. LGIM America’s Pension Solutions Monitor reported funded status declined modestly to 103.9% from 104.1% month over month. The Pension Solutions Monitor tracks the health of a typical U.S. corporate defined benefit plan.

LGIM America’s January data showed equities increased modestly, with global equities gaining 0.61% and the S&P 500 increasing 1.68%. Plan discount rates were estimated to have increased 7 basis points during the month, while the Treasury component increased 12 bps, and the credit component tightened by 5 basis points.

According to LGIM data, plans with a 50/50 asset allocation saw their assets decrease 0.46%, while liabilities dropped 0.29%.

LGIM’s tracker assumes a hypothetical portfolio of 50% MSCI AC World Total Gross Index / 50% Bloomberg U.S. Long Government Credit Index, with a duration of 12 years.

Agilis

Agilis, in its monthly pension briefing, reported most corporate pensions had a modest increase in funded status in January, driven by a reduction in liabilities. Plans with higher allocations to equities were more likely to have enjoyed increases in funded status.

According to Agilis, pension liabilities decreased between 1.5% and 2.0% as a result of rising discount rates in January. This reversed a two-month trend of decreasing interest rates, as the Federal Reserve had announced it would likely maintain the fed funds rate at current levels for the near future. Discount rates were also pushed upward by an increase in credit spreads.

Discount rates increased 0.18%, but Agilis noted that this is the smallest monthly increase since August 2023 and it is still indicative of volatility in the discount rate yield curve.

Asset returns were mixed in January. Outside of U.S. equities, most asset classes were negative for the month, noted Agilis. U.S. equities gained 1.1% in January, international developed market equites gained 0.6%, and emerging market equities dropped 4.6%.

“January highlighted what we expected to see throughout 2024, which is volatility in discount rates. With the Fed’s decision to hold the Fed Funds rate steady, along with sentiment that they may leave the rate unchanged in March, we saw an uptick in Treasury yields and also a widening of credit spreads,” said Michael Clark, a managing director at Agilis, in a statement. “The tug-of-war between the Fed’s actions and market sentiment are going to cause a lot of ups and downs throughout the year. For plan sponsors that are paying close attention, this could mean opportunities to lock in funded status gains as they appear with various changes in markets.”

October Three

October Three, in its monthly pension finance update, reported modest increases in pension finances, as higher interest rates largely outweighed mixed equity returns.

October Three tracks two hypothetical plans: Plan A, a traditional 60/40 portfolio, and Plan B, a portfolio aimed toward a population with more retirees that has an asset allocation of 20/80. Both model plans had funded status increases of a fraction of a percentage point in January.

Interest rates increased roughly 0.1% in January, which led to bonds declining 1%. As a result, both plans lost a fraction of a percentage point in assets. This was offset by a 1% decrease in pension liabilities, a result of corporate bond yields rising by 0.1%.

With discount rates moving slightly higher in January, October Three expects plan sponsors to use effective discount rates between 4.9% and 5.2% to measure their pension liabilities.

Insight Investment

According to Insight Investment’s monthly tracker, the funded status of U.S. corporate pension plans increased by in January to 108.2%, which Insight Investment attributed to an increase of approximately 17 bps in discount rates, a result of the change in the risk-free rate.

According to the tracker, assets lost 0.5%, while liabilities lost 2.0%.

“This recent period of heightened interest rate volatility highlights the importance of hedging interest rates to manage funded status risk,” the report stated.

Wilshire, in tracking the funded status of U.S. corporate pension funds through its FT Wilshire 5000 Index, found that funded status increased 1.1 percentage points to 106.1% in the month of January, continuing to break its own record for highest status since Wilshire began tracking funded ratios in 2012. The change in funded status was a result of a 1.9% decrease in liabilities, offset by a 0.7% increase in asset value.

“Although U.S. equity returns represented by the FT Wilshire 5000 were positive, negative returns for most other asset classes resulted in the total asset value decreasing,” said Ned McGuire, a managing director at Wilshire, in the report. “However, due to the larger decrease in liability values, the estimated funded ratio increased and remains at its highest month-end level in a couple decades.”