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%.