U.S. corporate funds show gain after 3 years of declines
The average funding ratio of the 100 largest U.S. corporate defined benefit plans jumped 4.7 percentage points to 89.2% in 2017 after years of small declines, Pensions & Investments' annual analysis of Securities and Exchange Commission filings shows.
"2017 was sort of a sigh of relief for a lot of (chief financial officers) and financial executives that I've talked to," said Brian McDonnell, managing director and global head of pensions at Cambridge Associates LLC in Boston.
The increased funding ratio in 2017 stopped a trend that saw the average decline to 84.5% at the end of 2016 from 85.1% in 2015 and 85.7% in 2014.
Aggregate assets of the top 100 plans rose 9% to $1.245 trillion and the aggregate funding deficit fell to $207.7 billion, down 19.5%, despite the plans using lower discount rates to project benefit obligations. The discount rate has an inverse relationship to plan liabilities and it has largely been in decline since 2008, when the average was 6.45%. The average rate used by the plans in P&I's universe fell to 3.68% in 2017, down 70 basis points from 2016. Only three plans raised their discount rates.
"The components of the discount rate that these corporate plans use is a high-quality corporate bond interest rate, so is influenced by both a rate and credit spread component," Mr. McDonnell said.
Credit spread changes present potential volatility to pension liabilities, but they often receive less attention than the Federal Reserve's interest rate moves, he said. "There was a lot of attention to the Fed raising rates, but as rates on the short end went up it did not mean the back end, the 30-year, was rising. If rates are going up because the economy is continuing to be strong, you could still get into a world where discount rates aren't moving anywhere if spreads further compress."
Mr. McDonnell said sponsors should avoid focusing on the impact of only one or two of the key levers that drive funded status — discount rates, contributions and the return on assets. "We don't see any of those levers moving enough to fix (the funded status) on their own. For an average plan that's 80% funded, you'd have to return 15% for five years, and that's unlikely to happen in the near-term environment. Hopefully, what sponsors took away from 2017 is that there's a balancing act between all of these levers," he said.
The average return on plan assets rose 5.8 percentage points to 12.3% in 2017 and all 100 of the plans in P&I's universe reported a positive return. Eighty-seven plans reported double-digit returns for the year. Ninety-seven plans had positive returns in 2016 when the average return on assets was 6.5%; 38 plans reported a positive return in 2015 when the average was 0.11%.
Morris Plains, N.J.-based Honeywell International Inc.'s return of 17.3% was the highest among P&I's universe. With $18.99 billion in plan assets and $18.15 billion in liabilities, the funding ratio rose 8 percentage points to 104.6% at the end of the year. The company's U.S. plans allocated 33.7% of the portfolio to domestic equities, with 14.9% of the portfolio in Honeywell common stock; 32.8% in fixed income; 13.9% to international equities; 8.7%, private equity; 5%, real estate; 4.8%, cash; 0.1% to hedge funds; and 1% to other investments.
International equities were the standout asset class in terms of returns, with the MSCI World ex-U.S. index returning 24.21% in 2017. The S&P 500 index gained 21.83% and the Russell 3000 index returned 21.13% for the period.
Long-duration U.S. corporate bonds also performed well in 2017, with the Bloomberg Barclays U.S. Long-Duration Corporate Bond index returning 12.09% for the year. The Bloomberg Barclays U.S. Long-Government Bond index returned 8.53% and the Bloomberg Barclays U.S. Aggregate Bond index, 3.54%. In international fixed income, the Bloomberg Barclays Global Aggregate ex-U.S. bond index had a one-year return of 7.39%.
A modest move
"It was such a strong year of returns but it came with the lower discount rates and, frankly, the needle only moved modestly upward for sponsors unless they were also making contributions," said Beth Ashmore, a senior retirement consultant at Willis Towers Watson PLC in St. Louis.
Ms. Ashmore said some companies took proactive steps to address the liability side of risk management. "Risk transfers via annuity purchases were up, with the annuity market having the most sponsors execute a sizable transaction in recent history. The annuity purchase marketplace ended up with just over $23 billion in transaction activity in 2017," she said.
According to its 10-K, United Technologies Corp., Farmington, Conn., contributed $2.19 billion to its plans in 2017 as part of the company's long-term pension derisking strategy. This follows UTC's derisking moves in late 2016, which transferred $768 million of U.S. pension obligations to a group annuity contract, along with a separate lump-sum distribution that reduced U.S. obligations by about $935 million. With $35.69 billion in assets and $37 billion in liabilities, the funded status rose to 96.5% in 2017 from 87.5% in 2016.
International Paper Co., Memphis, Tenn., contributed $1.29 billion to its U.S. plans in 2017 and purchased a group annuity contract from The Prudential Insurance Co. of America to "transfer approximately $1.3 billion of International Paper's U.S. qualified pension plan projected benefit obligations," the 10-K said. With $11.37 billion in assets and $13.26 billion in liabilities, the U.S. plans' funded status rose to 85.7% in 2017 from 75.4% the prior year.
"How sponsors respond to the improved funded status will be interesting. When you think about the funded status, it's not a story of the same thing happening across the board. Everybody has different objectives, different goals and different constraints," Ms. Ashmore said.
United Parcel Service Inc., Atlanta, made the year's largest contribution — $7.31 billion — and announced a future freeze effective Jan. 1, 2023, on benefit accruals for the UPS Retirement Plan and the UPS Excess Coordinating Benefit Plan, after closing the UPS Retirement Plan to new non-union participants in 2016. UPS also made $685 million in lump-sum distributions to about 22,000 former U.S. employees during the fourth quarter of 2016. According to the company's 10-K filing, UPS remeasured the assets and projected obligations for these plans as of June 30, 2017, and reported a net actuarial gain of $569 million.
The plans' funding ratio jumped to 91.5% from 76% in 2016. An 11.2% return producing $4.72 billion in gains also helped raise the fair value of plan assets by 34% in 2017 to $41.93 billion from $31.22 billion the year earlier and $28.89 billion in 2015. However, liabilities rose $4.78 billion in 2017 to $45.85 billion, partly due to the lower discount rate used to calculate benefit obligations, which dropped to 3.84% in 2017 from 4.41% the previous year.
U.S. Bancorp, Minneapolis, contributed $1.24 billion and had the highest jump in funded status in 2017, rising to 95.8% from 74.3% one year earlier. The plans had $5.48 billion in assets and $5.72 billion in liabilities at the end of the year.
Aggregate contributions by the plans in P&I's universe rose more than $20 billion in 2017 to a total of $52.46 billion from the previous year's aggregate $32.28 billion, with 14 plans in P&I's universe contributing more than $1 billion during the year. Only seven plans contributed $1 billion or more in 2016. (The aggregate figure includes global contributions when U.S.-only contributions were not available.)
"I think the most interesting thing was the scale of voluntary contributions into pensions. For many years, most plans just followed the minimum requirement, but we saw a lot of voluntary contributions at the end of 2017," said David Eichhorn, president and head of investment strategies at NISA Investment Advisors LLC in St. Louis.
Mr. Eichhorn noted several important drivers for the increase. Among them, earnings were strong in 2017 and companies had the cash on hand to contribute and tight corporate credit spreads. Some corporations also chose to accelerate future required contributions in response to an increase in Pension Benefit Guaranty Corp. premiums or to make their tax-deductible pension contributions before tax reform, which permanently lowers future corporate tax rates, became effective in January 2018.
"All of those aligned for some of the biggest voluntary contributions we've seen in a while," Mr. Eichhorn said.
Delta Air Lines, Atlanta, contributed $3.56 billion to its plans and saw the funded status leap to 68% from 49.4% in 2016. Assets rose to $14.74 billion from $10.3 billion, while liabilities increased slightly to $21.7 billion from $20.86 billion. This was the third consecutive year in which Delta contributed more than $1 billion, having put $1.32 billion into the plans in 2016 and $1.22 billion in 2015. Delta, which had the lowest funded status in P&I's universe for 12 consecutive years, also made a voluntary contribution of $500 million in January 2018. It now has the eighth-lowest funded status of the 100 plans studied.
The plans in P&I's universe have so far announced expected contributions of $27.23 billion for 2018. General Electric Co., Lockheed Martin Corp., PepsiCo Inc. and FedEx Corp. each expect to make contributions of $1 billion or more this year.
At the top of P&I's list, for the 13th consecutive year, was NextEra Energy Inc., Juno Beach, Fla. Its funding ratio rose to 155% in 2017 from 147.6% a year earlier. A 50-basis-point drop in its discount rate to 3.59% raised liabilities to $2.59 billion from $2.47 billion, while a 14.3% investment return lifted plan assets to $4.02 billion from $3.65 billion.
American Airlines Group Inc., Fort Worth, Texas, fell to the bottom of P&I's list in 2017 from second-lowest in 2016. However, its plans had a 15.8% return on assets and the company contributed $286 million during the year, bringing the funding ratio up to 62.4% from 58.1%. American Airlines expects to make supplemental contributions of $425 million to its U.S.-based plans in 2018 and anticipates higher mandatory contributions going forward. American Airlines had $11.4 billion in assets and $18.28 billion in liabilities at the end of 2017.
Showing the largest drop in funded status for the year was Sears Holdings Corp., Hoffman Estates, Ill., down 5.9 percentage points to 63.2%.
In May 2017, Sears purchased a group annuity contract from MetLife Inc. that transferred approximately $515 million in obligations for about 51,000 retirees. The company purchased a second group annuity contract from MetLife in August 2017 that transferred about $512 million in additional obligations for about 20,000 retirees. According to the 10-K, these actions "had an immaterial impact on the funded status of our total pension obligations, but reduced the size of the company's combined pension plan, reduced future cost volatility, and reduced future plan administrative expenses."
To further reduce obligations, Sears made a lump-sum distribution in the fourth quarter of 2017 of approximately $209 million to about 20,000 vested former employees. The plans had $2.53 billion in assets, $4 billion in liabilities and had the second-lowest-funded status in P&I's universe at the end of the year.