Corporate Pension Funds Are in Good Shape, So What’s the Worry?

Corporate defined benefit pension funds are in fine fettle: Goldman Sachs Asset Management says their funded status topped 100% last year, even as their investments lost 18%. Now the question is: What’s next for the funds?

In a commentary, Michael Moran, senior pension strategist at the investment firm’s asset management arm, warned against getting too comfortable. “Despite a strong improvement in funding ratios, now is not the time for plan sponsors to be complacent, as they must walk a tightrope of managing competing forces and priorities,” he told a Goldman interviewer in a company publication.

One possible problem, he said, is that many plan sponsors are escalating their 2023 estimated return on assets, or EROA, to potentially unsustainable levels, driven by the current rise in U.S. Treasury yields, among other factors. While that may help boost their parent companies’ net income (usually by reducing corporate expenses on the profit-and-loss sheet), it also risks “a greater chance of future shortfalls.” The higher they rise, the more painful the fall, if one happens.

Corporate plans now are more concentrated on bonds than stocks. Goldman statistics show that their average fixed-income allocation is 50%, with 29% in equities. That’s a shift from 10 years ago: 39% bonds, 42% stocks.

That changed allocation has helped funded status, as bonds suffered less in last year’s market wipeout than did stocks. But if the higher 2023 EROAs result from moving more into stocks, Moran warned that could entail both bigger losses ahead and more volatility. Some plans still suffer from a “mismatch” of assets and liabilities, he noted, meaning that not all have sterling funded statuses.

Meanwhile, the good news is much-welcomed by plans. The discount rate—the metric used to value the current cost of future obligations—has pushed up, thanks to rising interest rates, seen partly in widening credit spreads between corporate bonds and Treasurys. That, in turn, has led to a decrease in liabilities, a boon to plan sponsors.

The discount rate increased about 2.45 percentage points in 2022, “with many plans consequently seeing their liabilities fall by about 25%,” Moran pointed out.That more than made up for the 18% investment drop. The estimated discount rate last year was 5.4%. Higher returns today imply less need for contributions to plans in the future.

The systemwide jump in funded status to more than 100% marked the first time it reached that level since 2007, right before the global financial crisis.

Moran counseled that, “It is important that plan sponsors reviewing the various trade-offs manage them appropriately, taking into account their obligations as plan fiduciaries.”