A host of defined benefit plan sponsors have increased contributions to take advantage of a higher tax deduction, but now that the deadline to do so has passed, executives likely will get more conservative with asset allocations and work to reduce pension liabilities.
The Tax Cuts and Jobs Act, signed into law in December, reduced the corporate tax rate to 21% from 35%. Current tax law allows a company to deduct a portion of its pension contributions based on its tax rate. Corporations had until Sept. 15, the final tax deadline, to deduct those contributions at the higher 2017 rate.
"Certainly when the change in the tax rates passed that raised questions to see if there were any opportunities, and this one very quickly became a prime opportunity for plan sponsors to achieve multiple objectives: take advantage of the tax change while improving the funded status of the pension plans," said Bruce Cadenhead, New York-based vice chairman of the American Academy of Actuaries' pension committee.
In 2018, at least 25 companies have contributed or announced plans to contribute a total of $14.4 billion to U.S. pension plans, according to Pensions & Investments' news stories. Many cited tax reform as a reason for making larger than normal contributions. A further 35 companies announced $18 billion in total global contributions this year, without specifying how much was headed for U.S. plans. P&I only reported on S&P 500 companies intending to contribute at least $100 million to global plans.
About a month after the tax bill was signed into law, Lockheed Martin Corp., Bethesda, Md., announced it would contribute $5 billion to its U.S. DB plans in 2018. Also, in January, FedEx Corp., Memphis, Tenn., announced an additional $1.5 billion to its U.S. pension plans on top of the $1 billion it had previously disclosed. And in February, PepsiCo Inc., Purchase, N.Y., announced in a 10-K filing that it would make a total of $1.4 billion in DB plan contributions this year.
As of Sept. 10, the aggregate funding ratio for U.S. pension plans in the S&P 500 improved to 89.4% from 85.6% this year, according to the Aon Hewitt Investment Consulting's pension risk tracker.
"There are a lot of companies out there that have pensions plans that are significantly underfunded, and they knew they'd have to make contributions to them at some point, and the change in the tax rates just provides a huge incentive," Mr. Cadenhead said.
Grant Verhaeghe, senior director and asset-liability practice leader at CAPTRUST Financial Advisors based in Raleigh, N.C., said some clients have made special contributions from balance sheet assets that they were not otherwise planning to make and a few have tapped into lines of credit to make contributions.
"This is the only time they will get a return like this for something they were planning to do anyway," Mr. Verhaeghe said.
Now that the deadline has passed, sponsors likely will set their sights on derisking strategies, said Rohit Mathur, a senior vice president and head of global product for pension risk transfer at Prudential Financial.
For companies that announced or made their contributions early, this process is already underway. In May, FedEx announced it had entered into an agreement to purchase a group annuity contract with Metropolitan Life Insurance Co. to transfer about $6 billion in U.S. pension plan obligations. It is the largest such transaction in the U.S. since Verizon Communications Inc., New York, purchased a group annuity contract from Prudential Insurance Co. of America in 2012 to transfer $7.5 billion in U.S. pension plan obligations.
According to Mr. Mathur, Prudential is seeing more interest and activity from plan sponsors when it comes to transferring pension obligations to insurance companies.
"As many of these plans over the years have become closed or frozen and the newer participants in these companies are not getting these benefits, it's largely a legacy obligation," Mr. Mathur said. "Companies are finding that transferring such risk to an insurance company is preferable. The sponsors themselves, their core competence is more in making the products they make. It's not necessarily in asset-liability management."
Better funded pension plans also are likely to lean more conservative in terms of asset allocation. Mr. Verhaeghe expects to see higher allocations to fixed income, especially high-quality corporate bonds for a liability-driven investment strategy.
For open plans, Mr. Cadenhead said investment strategies might become more conservative, but it's more likely executives simply will stay the course. But with frozen plans, especially those of sponsors that are anticipating termination of the plan, the change in the tax code might have sped up the timetable, he added.
"A lot of pension plans have been frozen in recent years, so for many plan sponsors, if the plan is frozen, then you're thinking about, 'How can I terminate the plan, buy annuities and just be done with this obligation?' " Mr. Cadenhead said. "These contributions have brought a lot of plans at least closer to being able to afford to buy the annuities."
Now that more plans are better funded, Mr. Mathur expects more sponsors to explore termination. Although the trend is in its early days, "over time you'll see more companies at least contemplate" plan termination, he added.
For the plans now closer to and considering termination, Mr. Cadenhead said sponsors likely will reduce risk not only through investing more conservatively in fixed income but also by buying annuities for some or all of their retirees.
"What many plan sponsors are finding is that if you're looking at just a portion of the population, insurers like the predictability of retiree obligation and so it tends to be more cost effective if you can't terminate the whole plan to just focus on retirees," Mr. Cadenhead said.
Post-Sept. 15, corporations have less incentive to make pension contributions. Beth Ashmore, a senior retirement consultant at Willis Towers Watson PLC based in St. Louis, said she expects a "cooling off" in terms of contributions because the deadline motivated many companies to make additional contributions in 2018.
"By accelerating some of those contributions they're saying, 'I'm doing this under the intent that I shouldn't have to go back to my board or senior management and ask for more capital for the pension plan for a while,'" Ms. Ashmore said of chief financial officers.
But with rising Pension Benefit Guaranty Corp. premiums, corporate sponsors still will make a concerted effort to keep plans well funded, Mr. Mathur said. "Even under the lower tax rate, we still think the math is going to be compelling for a number of companies to continue funding their plans," he said.