Corporate defined benefit plan sponsors likely will step up allocations to liability-driven investing and raise pension contributions in coming months, according to pension strategists.
Corporate balance sheet derisking and rising variable-rate premiums of the Pension Benefit Guaranty Corp. are key drivers of the moves.
“We do anticipate that more plans will add to their LDI portfolios over time as funded levels move higher, whether that (will) be due to higher interest rates or ... larger incremental contributions,” said Michael A. Moran, pension strategist, Goldman Sachs Asset Management Inc., New York. “When the 10-year (Treasury note) is at 1.65%, it may seem a little surprising that some plans are concerned about (LDI). But maybe this is a 1% world.”
“We are having more conversations” with clients about making LDI moves, said Mr. Moran, who declined to name any.
LDI or other long-duration bond strategies have performed well for pension funds, said Michael A. Archer, Phila- delphia-based senior consulting actuary, Willis Towers Watson PLC.
The Barclays Capital U.S. Long Credit index has returned 11.82% so far this year through June 15, Mr. Archer said.
The long credit index has a duration of 13.9 years, compared to the 5.5-year duration of the Barclays Aggregate index, which covers the broad universe of bonds, Mr. Archer said. Pension funds typically have a 13.9-year duration for their liabilities, Mr. Archer added.
With the long-duration performance this year, Mr. Archer said pension funds with 40% exposure to long fixed income already have a “5% (return) in the bank, and they've gotten a little bit of return from equity. So (almost) halfway through the year, they are doing fine” in their attempt to meet their assumed rate of return, Mr. Archer said.
Pension funds with 75% equity exposure “are probably behind (in their return expectation) at this point in the year. It's still awfully early,” he said.
This year through June 22 on a total return basis, the S&P 500 was up 3.14%, while the MSCI Europe Australasia Far East index was down 0.95%.
For pension funds, the greater the exposure to long fixed income, “the better off they are” in the current market environment, Mr. Archer said.
In addition to their investment returns, corporate plans sponsors “are at a turning point” in raising contributions after three consecutive years of decline, despite continuing federal pension funding relief, Mr. Moran said.
Even though pension contribution funding relief was extended by the Bipartisan Budget Act of 2015 through at least 2020, and many corporate plans have little to no mandatory contribution requirement, “we are seeing ... more and more (corporations) saying ... the economics to making a contribution today makes lot more sense,” Mr. Moran said.
Among S&P 500 companies, total contributions for their plans could rise to an estimated $35 billion to $50 billion in 2016, up from $30 billion in 2015, which was the lowest total contribution since $29 billion in 2008. For all corporations with defined benefit plans, Mr. Moran estimates contributions could rise to between $70 billion and $100 billion in 2016, up from about $60 billion last year.
Rising PBGC variable-rate premiums are a big part of what is driving the move to higher contributions, Messrs. Moran and Archer said. The rate — 3%, or $30, of every $1,000 of underfunding in 2016 — is scheduled to rise to 4.1% in 2019, more than four times the 0.9% rate in 2013, Mr. Moran said.
As a result, the rising PBGC rate trumps pension funding relief in corporate decision-making on contributions, they said.
But the PBGC caps the variable-rate premium at $500 per participant, Mr. Archer said.
“Companies above the cap may be less likely to fund (contributions) and more likely to try to reduce the number of people in the plan,” Mr. Archer said. Such a participant reduction also would save plan sponsors on the rising PBGC fixed-rate premium. At $64 per participant in 2016, it is scheduled to rise to $80 in 2019, up 128% from $35 in 2012.
“We are starting to have more conversations (with plan sponsors),” Mr. Moran said. “One of the strategies we have talked with (them) about is (in a) low-interest-rate environment that's really hurting DB plans, what's the way to make low interest rates work for you. As a sponsor you, take advantage of the low rates by issuing debt ... and then contributing” the proceeds to the pension funds.
Messrs. Moran and Archer see more companies issuing debt to finance pension contributions, as General Motors Co. did earlier this year with a $2 billion debt offering, the proceeds of which were contributed to its pension plans.
Mr. Moran said he has been talking with clients considering such a debt strategy, while Mr. Archer said he knows of other companies that have sold debt to finance pension contributions. Neither strategist would identify any company.