US Pension Funded Status Continues to Improve in May

Despite negative returns for many asset classes in the stock market, decreasing liabilities resulted in U.S. corporate pension funded status improvements in May, according to analysts.  

Pension discount rates rose almost one-quarter of a percentage point in May, erasing much of the fall in rates that had been seen so far this year, according to Agilis’s May Pension Briefing. 

This boost in funded status comes on the heels of a strong April for pension plans, as an increasing number of pension plans are reaching fully funded status. Recent trends also indicate that many U.S. corporations are lowering their planned contributions. 

Pension Plan Sponsors Optimistic About Future  

Despite the challenges of last year’s U.S. public pension plans, analysts at Equable Institute say that pension plans are currently in better shape than they were before the COVID-19 pandemic.  

According to a report published in June by Dutch firm Ortec Finance, the average funded ratio for U.S. public pension plans was 77.89% in 2022, with collective unfunded liabilities of $1.445 trillion.  

However, Ortec Finance’s study reported that pension plans are coming to grips with the issues they face and are optimistic about the future. Many pension plan managers are convinced that inflation as a major issue is fading away, with the U.S. economy on a path to inflation moderation. 

“While public sector pension plan managers are generally confident that they have addressed inflation by hedging on their funds, they aren’t getting complacent,” the Ortec Finance report stated. “More work is being done in terms of asset allocations, with commodities emerging as the clear favorite for increased exposure in the year ahead, and there are some lingering worries that the U.S. economy will not achieve the soft landing of lower inflation and rising growth.” 

Ortec Finance argued that funding ratios are still under pressure, which stresses the importance of asset-liability management to improve the long-term financial position of the plans.  

Negative Investment Returns 

While equity market returns were generally negative in May, large-cap domestic equities showed positive returns for the month, driven by better-than-ever expected results from mega-cap companies, Agilis reported. 

The firm found that the Treasury yield curve rose approximately 20 basis points during the month of May, with short-term rates rising even further. With credit spreads on long credit staying relatively flat, corporate bond yields and pension discount rates also rose approximately 20 to 25 bps, yielding negative returns, Agilis stated. 

Worries about a potential U.S. debt ceiling agreement also kept equity markets in turmoil, with most indexes ending the month down despite a deal being reached in advance of the deadline.  

“All eyes will continue to be on key economic indicators (i.e. inflation, wage inflation, earnings, unemployment, and PMIs) and how they interact to influence discount rates and market returns,” said Michael Clark, managing director at Agilis, in a statement. “2023 is still looking like a good year to implement lump sum cashout windows from an overall pension finance viewpoint, as discount rates are down compared to where they were last fall. Pension plan sponsors need to start taking steps now to take advantage of this opportunity.” 

The WTW Pension Index also continued to increase in May, as the reduction in liabilities as a result of increases in discount rates, partially offset by negative investment returns, contributed to raising the end-of-May index to 102.5, an increase of 1.7% for the month. 

The equity portion of WTW’s benchmark portfolio returned negative 0.7% in May, with the international equity asset class incurring the largest losses. The fixed-income investments of the tracked investment portfolio also had a negative return at 0.9%, with long Treasury bonds and long corporate bonds experiencing the largest losses. 

In addition, WTW found that yields on long, high-quality corporate bond indices increased an average of 26 bps. 

Overall, the liability implicit in the index decreased by 2.4% from the discount rate change and the accumulation of interest, resulting in an increase in funded status, according to WTW. 

High Interest Rates Boost Funded Status 

Based on market movements, LGIM America’s May Pension Solutions Monitor found that the average funding ratio is estimated to have increased to 100.7% from 100.5%. 

Equity markets were mixed throughout the month, as Global Equities decreased 1.0% and the S&P 500 increased 0.4%, according to LGIM. Plan discount rates were estimated to have increased roughly 26 bps over the month, with the Treasury component increasing 22 bps and the credit component widening 4 bps, the firm reported. 

Plan assets with a traditional “50/50” asset allocation decreased 1.9%, while liabilities decreased 2.1%, resulting in a slight improvement in funding ratios by the end of May. LGIM found that the drop in liabilities outweighed the lag in asset performance. 

October Three Consulting similarly found that high interest rates gave pension finances a boost in May. As interest rates moved back above 5% in April, close to levels seen at the end of 2022, tech stocks have led to an increase in stock portfolios this year, according to October Three. 

If this trend holds, it will mark the third consecutive year of capital market tailwinds for pension sponsors, the firm reported. 

October Three also noted that new laws, such as pension funding relief signed into law in March and November of 2021, substantially relaxed funding requirements over the next several years. However, the increase in rates in the past year has “eroded the impact of relief.” 

Because discount rates moved higher in May, October Three predicted that most pension sponsors will use discount rates in the 4.9% to 5.2% range to measure pension liabilities right now.  

Milliman observed that an increase in the benchmark corporate bond interest rates used to value pension liabilities led to a decrease in these liabilities of $41 billion for the month. That decrease in liabilities was a major factor in the funded ratio’s increase to 100.7% as of May 31, up from 99.6% at the end of April.

According to Milliman, a funding deficit at the beginning of May changed to a funding surplus of $9 billion by month’s end. The Milliman 100 Pension Funding Index projected benefit obligation decreased to $1.32 trillion in May. This change resulted from an increase of 27 bps in the monthly discount rate, to 5.19% for May from 4.92% in April.

Milliman predicted that funded status will rise to a surplus of $20 billion (funded ratio of 101.5%) by the end of 2023.

Wilshire Associates’ U.S. Corporate Funded Status additionally found that the aggregate funded ratio for U.S. corporate pension plans increased by an estimated 0.8 percentage points month-over-month, ending May at 99.8%.  

The monthly change in funded ratio resulted from a 2.9% decrease in liability value partially offset by a 2.0% decrease in asset value. The aggregate funded ratio is estimated to have increased by 2.3% and 2.4%, year-to-date and over the trailing 12 months, respectively, according to Wilshire.  

“Notably, the FT Wilshire 5000 index experienced gains in May driven by a small number of companies with significant positive returns,” stated Ned McGuire, managing director at Wilshire. “With May’s month-end funded ratio estimate of 99.8%, U.S. corporate pension plans are nearing full funding in aggregate, reaching the highest level since year-end 2007.” 

Sweta Vaidya, North American head of solution design at Insight Investment, also observed that funded status improved by 1.1% to 102.8% in May from 101.7% in April.  

“The increase was driven by a 26 [bps] increase in discount rates, which decreased liabilities while asset returns were mixed,” Vaidya said. 

She added that uncertainty about the debt ceiling has “highlighted the importance of liquidity planning for pension investors.” Overall, Insight Investment found that assets decreased by 2.2% and liabilities decreased by 3.2% in May.  

Aon’s Pension Risk Tracker reported that the S&P 500 aggregate funded status increased to 99.2% in May from 98.3%. Pension asset returns were down throughout May, ending the month with a negative 1.3% return. 

In addition, the month-end 10-year Treasury rate increased 20 bps relative to the April month-end rate, and credit spreads widened by 4 bps.  

“This combination resulted in an increase in the interest rates used to value pension liabilities from 4.85% to 5.09%,” Aon’s report stated. “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 offset the positive effect of asset returns on the funded status of the plan.”