While the Federal Reserve raised interest rates again in May, most analyst firms found that corporate pension funding status increased marginally in April, as the month’s strong investment returns partially offset increased liabilities.
Wilshire Associates reported that the aggregate funded ratio for U.S. corporate pension plans increased by an estimated 0.4 percentage points month-over-month in April, ending the month at 99.4%.
The monthly change in funded ratio resulted from a 0.5% rise in asset value, while the liability value remained unchanged, according to Wilshire. The aggregate funded ratio is estimated to have increased by 1.9 percentage points and 1.4 percentage points, year-to-date and over the trailing 12 months, respectively.
“April’s funded status was a result of an increase in asset value,” stated Ned McGuire, managing director of Wilshire. “Fixed-income yields declined slightly on continued signs of cooling inflation and expectations of the Federal Reserve interest rate hikes near completion. With positive returns for most asset classes for a second consecutive month, U.S. corporate pension plans are inching towards full funding in aggregate.”
April increases followed what most analyst firms agreed was a pension funded status decrease in March, as a decline in discount rates raised liabilities by more than the growth in equities.
Corporations Contributing Less
As more pension funds continue to reach fully funded status, recent trends indicate that U.S. corporations are lowering their planned contributions.
According to Brian Donohue, a Chicago-based partner in October Three Consulting, contributions have been trending down among 212 Fortune 500 employers that sponsor pension plans, to $13 billion in 2022 from $48 billion in 2018.
Donohue said this trend is expected to continue in 2023, with companies disclosing intended contributions this year of just $3 billion.
Funding ratios improved significantly in 2022 because of rising discount rates, which caused corporations to not have to make minimum required contributions for their plans. This is positive news for many corporations, as it is possible that companies might not have to make contributions again.
Equity Markets Rally
LGIM America’s April Pension Solutions Monitor showed that the average funding ratio is estimated to have increased to 100.5% from 100.3%.
Equity markets rallied through the month, according to LGIM, with global equities and the S&P 500 increasing 1.5% and 1.6%, respectively. Plan discount rates were also estimated to have decreased roughly 5 basis points over the month, with the Treasury component decreasing 3 bps and the credit component decreasing 2 bps.
In addition, LGIM found that plan assets with a 50%/50% bond/stock asset allocation increased 1.1% while liabilities increased by 0.9%, resulting in slight improvement in funding ratios by April month-end.
Overall, LGIM concluded that the combination of stronger asset performance and rising liability values kept funding ratios relatively unchanged throughout the month.
October Three found similar results, as the firm said pension plans have “managed to hang on to the significant improvement in funded status over the past two years.” Even though interest rates have drifted lower this year, positive stock markets have allowed plan sponsors to keep pace so far, October Three’s report stated.
The firm also found that bonds gained about 1% last month. For the year through April, a diversified bond portfolio earned 4% to 7%, with long-duration bonds performing best.
Corporate bond yields fell 5 bps in April, and as a result, pension liabilities rose 1% during the month and are now up 5% to 7% for the year through April, October Three found.
The WTW Pension Index also saw an increase in April as a result of positive investment returns, partially offset by an increase in liabilities due to a small decrease in discount rates. Overall, WTW’s index level of 100.8% reflects an increase of 0.2 percentage points for the month.
WTW tracks the performance of a hypothetical pension plan invested in a 60% equity/40% fixed income portfolio, which received a 1% return for the month. In addition, the liability implicit in the index increased by 0.8% from the discount rate change and the accumulation of interest.
Mixed Global Equity Market Returns
Agilis’s Pension Briefing reported that funded statuses improved slightly for plans with significant allocations to large cap developed market equities, but plans with more significant allocations to emerging market stocks or small caps could have seen funding levels decrease.
The Treasury yield curve leveled out slightly in April, with very short-term interest rates increasing and long-term bond yields decreasing, while credit spreads narrowed as stresses in the market eased. These changes were positive for bond market returns but resulted in a slight decline in discount rates which increased liabilities, according to Agilis.
Meanwhile, global equity market returns were mixed, according to Agilis, as large-cap developed markets had positive returns, and emerging markets, as well as mid- and small-cap stocks, reported negative returns. The fixed-income markets were generally positive.
“With the Fed raising the Fed Funds Rate for the 10th time in a row in early May, the markets are now expecting them to hold steady and potentially start cutting the rate later this year, even though the Fed is saying they are most likely to hold steady,” said Michael Clark, managing director at Agilis. “With another strong jobs report, a lot will depend on what happens with inflation and any potential negative economic event that may play out (e.g. debt ceiling debates, geopolitical escalation). As we’ve said before, pension plan sponsors will continue to deal with uncertainty and volatility in 2023.”
On the positive side, Agilis found that volatility decreased in April, thanks to easing worries about regional banks and better-than-expected first-quarter earnings. The job market also remained strong, as U.S. companies added 296,000 jobs in April, up from 142,000 in March, although initial jobless claims rose modestly.
Because the Fed raised interest rates again in May, Agilis’s report said there is little agreement about what the rest of the year will hold.
“Meanwhile, the U.S. House of Representatives passed a debt-ceiling bill in an effort to avoid a government shutdown, but the bill moves to the Senate, where passage will be more difficult,” the report states. “With this political uncertainty on the horizon, we anticipate more market volatility that will cause pension funded status to fluctuate as well.”
Some Say Funded Status Deteriorated
Aon’s Pension Risk Tracker found that while the aggregate funded ratio for pension plans in the S&P 500 increased to 98.3% from 98.2% in the first quarter of 2023, the S&P 500 aggregate pension funded status decreased slightly during the month of April, to 98.3% from 98.5%
Pension asset returns, however, were up slightly throughout April, according to Aon, ending the month with a 0.8% return.
The pension funding deficit has decreased by $1 billion so far this year, and Aon said this has been driven by assets growing $51 billion, offset by a liability increase of $50 billion year-to-date.
Aon also found that the month-end 10-year Treasury rate decreased 4 bps relative to the March month-end rate, and credit spreads remained constant.
“This combination resulted in a decrease in the interest rates used to value pension liabilities from 4.89% to 4.85%,” 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.”
Despite investment gains in April, Milliman’s Pension Funding Index reported that funding of the nation’s 100 largest corporate pension plans decreased by $7 billion during April. A decrease in interest rates used to value pension liabilities also resulted in an increase in liabilities of $10 billion for the month, Milliman fund.
As of April 30, Milliman said the funded ratio fell to 99.5% from 100.1% at the end of March.
Looking ahead, if the Milliman 100 PFI companies were to achieve an expected 5.8% average investment return, and if the current discount rate of 4.92% were maintained during 2023 and 2024, Milliman forecasts that the funded status of the surveyed plans would increase.