Navigating pension risk in today’s economic climate

Today, many plan sponsors may find themselves in unfamiliar waters, with higher bond yields, lower expected equity returns and the possibility of a looming recession. Changes in the economic climate can make this an ideal time for plan sponsors to re-examine their risk-management strategies.

Assessing the impact on plan funding ratios

The average market value funding ratio for single-employer U.S. pension plans has reached a post-global financial crisis high. At the beginning of 2023, funding ratios averaged almost 100%, compared to less than 80% at the low point in 2009.¹ With much smaller funding shortfalls (if any at all), pension portfolios can generate gross returns sufficient to cover liability interest and accruals while assuming much less investment risk.

The traditional strategy for reducing pension funding risk is increasing investment in duration-matching high-quality bonds (often called liability-driven investing or LDI). During the last decade, plan sponsors have expressed several legitimate arguments against increasing their LDI exposure:

• Large funding gaps required aggressive return-seeking;
• LDI would lock in weak funding positions;
• Interest rate volatility was thought to be one-directional (i.e., rates can only go up); and
• Long-term bonds seemed too expensive and yields too low.

Large funding gaps made it difficult to give up the robust performance consistently delivered by stocks. Because of rising rate expectations, it was more advantageous to keep fixed-income portfolios at shorter durations to benefit from net gains, as opposed to holding longer-duration liabilities, which would lose value when rates increased. In many ways, it seemed pension plan sponsors did not have much to lose by maintaining a traditional gross return focus on pension investing.

In the current economic environment, however, these arguments have lost considerable power. The differences can be seen in the table below, which shows a sample comparison of funding status between the end of the global financial crisis (2009) and 2023.

Visit principal.com/definedbenefit to view the full white paper, including additional insights on:

• The need for increased customization of investment strategies as funding ratios increase;
• How current economic conditions open up options for plan sponsors to consider alternative risk transfer options, including annuity buy-ins, as part of their risk management strategy; and
• The availability of real-time data and how it has increased the ability to help successfully execute pension risk management strategy.