By: Russ Kamp, Managing Director, Ryan ALM, Inc.
As everyone knows, corporate defined benefit (DB) plans have been disappearing like the dinosaur. However, rising US interest rates following a 39-year bond bull market might just prove to be the antidote needed to stem this tide. Milliman’s 2022 Pension Funding Study is out, and as usual, it provides a great overview of the top 100 corporate plans (ranked by plan assets). Corporate funding has improved dramatically in the last several years as investment returns have eclipsed the average plan’s return on asset (ROA) assumptions by a substantial sum. At year-end 2021, corporate pension funding stood at 96.3% compared to 88.1% at year-end 2020. According to the study, only 1 of the 100 plans in this study failed to see improvement in their funded status.
Furthermore, expenses associated with offering a DB plan have fallen substantially. In fact, the aggregate improvement in funding created $18.1 billion in pension earnings (credit) in 2021. There were 53 plans in this study that reported pension earnings in 2021. Importantly, this is the first time that we have had pension earnings since 2001. In addition, and despite the increase in PBGC premiums, total PBGC expenditures fell during fiscal 2021, too. These developments are potentially watershed events.
Despite the struggles year-to-date for both the bond and equity markets, corporate funding has likely continued to improve as the present value impact on plan liabilities from rising US interest rates will have been greater than the losses incurred on the asset side of the pension ledger. Could funded ratios eclipse 100%? If the Federal Reserve is true to its word and given its hyper-focus on inflation, US interest rates could see substantial increases. If such an action occurs, it would not be surprising to once again see aggregate funding achieve fully-funded status. Would this success encourage Corporate America to reduce actions designed to eliminate pensions, such as Pension Risk Transfers (PRT)? We could only hope. Furthermore, the “Great Resignation” that we’ve been witnessing may be tempered with the ongoing support of DB pension systems.
It is also critically important to understand that pension risk transfers are not a panacea. According to Milliman, “PRTs in the form of buyout programs are deemed by plan sponsors to be an effective way to reduce a pension plan’s balance sheet footprint, but generally they have an adverse effect on the plan’s funded status (my emphasis), as assets paid to transfer accrued pension liabilities are higher than the corresponding actuarial liabilities that are extinguished from plans. Much of this incongruity stems from Financial Accounting Standards Board (FASB) pension plan valuation rules, which differ from an insurance company’s underwriting assessment of the same liabilities.” Moreover, we are now witnessing a positive impact on the income statement thru pension income for the first time since the 1990s.
With lower costs, improved funded status, and a need to keep staff during these volatile and challenging times, is it too much to hope that a new day may be dawning for traditional DB pension plans? There are wonderful investment strategies that can be used to lock in the improved funding and secure the promised benefits. We believe that a cash flow matching strategy can secure benefits at a much lower cost than a PRT. We also believe that cash flow matching is the only LDI/ALM strategy that also ensures the necessary liquidity to meet the promised benefits and corresponding expenses. We’d welcome the opportunity to provide assistance to any plan looking for ways to keep its pension plan thriving. Lastly, asking untrained employees to fund, manage, and then disburse a “retirement” benefit through a defined contribution plan is not a good policy. These supplemental plans may also create an unintended consequence given the portability. Let’s go back to the future!