Higher rates lower liabilities, could hurt expenses

A 57-basis-point increase in the average discount rate lowered projected liabilities an aggregate 8.1% to $1.335 trillion for the 100 largest U.S. corporate defined benefit plans and helped decrease the aggregate funding deficit by 17.4% to $171.5 billion in 2018, Pensions & Investments' annual analysis of Securities and Exchange Commission filings shows.

"The higher interest rates help us on the liability side but they might hurt us on the pension expense side," said Zorast Wadia, a New York-based principal and consulting actuary at Milliman Inc.

Interest cost is one of the components used to calculate the expense of pension benefits as reported on the income statement of corporate balance sheets, Mr. Wadia said. "The interest cost is essentially your liabilities at the beginning of the year multiplied by your plan's discount rate. You're multiplying two numbers together, and when interest rates increase, it helps one of the numbers but it hurts the other number," he said.

The liabilities of a mature plan that is closer to winding up tend to be less sensitive to interest-rate movements than a more active plan with a longer duration so the increased interest cost for more mature plans might not be fully offset by lower liabilities, he said.

Mr. Wadia, a co-author of the Milliman 100 Pension Funding index, said the aggregate pension expense for the plans in Milliman's study decreased to $16.2 billion in 2018 from $20.3 billion one year earlier. Pension expense has been trending downward in recent years from an all-time high of $56.5 billion in 2012 but Mr. Wadia said this trend is likely to be reversed in 2019.

"Given the higher discount rates and depressed asset returns in 2018, the prediction is that sponsors will actually see an increase in 2019 pension expense," he said.

In addition to interest cost, pension expenses include new benefit accruals plus recognized actuarial losses or gains plus curtailments and settlements minus amortization and expected return on assets.

Many sponsors looking to hedge against the impact of interest-rate volatility by increasing the plans' allocation to liability-matched fixed income are using outsourced chief investment officer services to shift allocations more quickly and efficiently when opportunities arise, said Clint Cary, managing director and head of U.S. delegated investment solutions at Willis Towers Watson PLC in Chicago.

Mr. Cary said delegating the execution of a plan's strategic investment goals to an OCIO can help defined benefit plan sponsors avoid delayed asset allocation changes when funded status improves.

"Being nimble and dynamic around asset allocation has always been a reason to partner with an OCIO. An OCIO tends to be better able to implement dynamic derisking," he said.