After years of recovery, corporate plans near full funding

The funded status of U.S. corporate defined benefit plans has improved to levels not seen since before the financial crisis over a decade ago, better positioning their sponsors to execute risk mitigation strategies.

Estimates from multiple investment consultants and money managers show the aggregate funding ratio for U.S. corporate DB plans exceeded 95% as of Dec. 31, the best showing since before the financial crisis of 2008.

Among the firms providing estimates is Goldman Sachs Asset Management, which said in a report released Jan. 5 that the aggregate funding ratio reached 100% as of Dec. 31. Michael Moran, New York-based senior pension strategist for GSAM, said in a phone interview it was a banner year for corporate pension plans.

"We had higher interest rates (and) equities obviously had another great year in 2021," Mr. Moran said. Because of those higher interest rates, most corporate plans will likely increase their discount rates by about 30 to 40 basis points, "or maybe a little bit more," he said.

The GSAM estimate, which shows the funding ratio jumped from an aggregate 89.4% as of Dec. 31, 2020, cites a total of 15.1 percentage points in increases in returns, net actuarial gains and contributions as the primary drivers of the increase in funding ratio, partially offset by 6.5 percentage points in losses due to interest costs, service costs and benefit payments.

The improvement in funding ratios over the year also contributed to increased pension risk transfer activity in 2021. GSAM estimated a total of $29 billion was transferred in 2021, the highest number since 2012 when jumbo transactions from General Motors Co., Detroit, and Verizon Communications Inc., New York, drove volume up to $36 billion.

The two largest transactions in 2021 were completed by HP Inc., Palo Alto, Calif., which purchased a group annuity contract from Prudential Insurance Co. of America to transfer about $5.2 billion in U.S. pension plan liabilities, and Bethesda, Md.-based Lockheed Martin Corp., which purchased group annuity contracts from Athene Holding Ltd. to transfer about $4.9 billion.

Mr. Moran said that activity should continue to rise this year.

"We certainly expect more plans to continue their derisking actions," Mr. Moran said, "That will be increased pension risk transfer for some cases, and that will include higher allocations to fixed income to better match their liabilities."

"I do think that that wave is coming, too," added Matt McDaniel, Philadelphia-based partner in Mercer's wealth business, in a phone interview. "We've definitely seen an uptick in interest and activity requests, especially around full plan termination activity. Those take a year or two to pull off, but it does indicate to me there's a lot more activity coming in that market in the next two, three, four years."

In its own estimate, Mercer estimated the aggregate funding ratio of pension plans sponsored by S&P 1500 companies increased to 97% as of Dec. 31 from 84% a year earlier. It is the highest ratio achieved since year-end 2007 when the estimated aggregate funding ratio reached 104%.

"Almost 40% of plan sponsors in the S&P 1500 we're estimating are going to be 100% or better, and that's a pretty big number," Mr. McDaniel said. "Certainly the highest it's been in quite some time."

The increase in interest rates is the difference maker, according to Mercer's estimate. The typical discount rate measured by the Mercer Yield Curve increased to 2.76% as of Dec. 31 from 2.32% a year earlier, although it's still well below its 6.04% level at the end of 2007.

Mr. McDaniel said corporate sponsors' efforts to derisk their plans for the past 15 to 20 years has positioned them far better than they were positioned before the financial crisis.

"Certainly plan sponsors are better protected today than they were in 2007 from downturns in the markets. We've seen much more ongoing prevalence of liability-driven investing and liability hedging leading to reductions in allocations to equities as funded status improves," Mr. McDaniel said.

"An equity market correction would not surprise me in the least sometime in 2022," he added. "Some plan sponsors will shrug that off as insignificant because they're so well insulated from market shocks. It won't really bother them."

Joseph Gamzon, New York-based managing director, retirement, at Willis Towers Watson PLC, said in a phone interview that a number of clients reduced their allocations to equities several times in 2021 due to the ongoing improvements in their funded status during the year that brought them further along their LDI glidepaths.

A Willis Tower Watson examination of data from 361 Fortune 1000 companies that sponsor DB plans estimated the funding ratio reached 96% as of Dec. 31, up from 88% a year earlier and the highest estimated ratio since the firm's estimate of 107% as of Dec. 31, 2007.

The improved funding "really gives plan sponsors the option to go in a number of different directions if they want," Mr. Gamzon said.

U.S. corporate pension plans reach nearly 100% funded status at the end of 2021, an achievement not seen since before the financial crisis.