The last time corporate pension plan funded status looked this healthy was as of Dec. 31, 2007, when P&I’s analysis showed an average funding ratio of 108.6%. That all came quickly crashing down, however, with the global financial crisis. Just one year later, the average funding ratio plummeted nearly 30 percentage points to 79.1%.
Now, however, there is new stability, and it began in 2022. Corporate pension plans benefited mightily from rising interest rates during the year. The average discount rate rose to 5.25% as of Dec. 31, 2022, from 2.88% the year before, which caused liabilities to plummet and offset poor investment performance during the period.
That dramatic rise in discount rates came primarily as a result of the Federal Reserve's aggressive fight against inflation, that would eventually reach its end point in July when the central bank raised the federal funds rate to a range of 5.25% to 5.5%.
Suddenly, corporate pension plans found themselves fully funded on average.
“2022 felt like it changed everything,” said Brian McDonnell, head of the global pension practice at Cambridge Associates. “Plans all of a sudden were fully funded, and they didn’t really anticipate they would have an opportunity to see that in the near term. I don’t want to say it was a scramble, but all of a sudden, they had options on their doorstep that they didn’t think they’d have yet.”
Many corporations with defined benefit plans have worked for years at derisking their plans, through such methods as liability-driven investing, closing or freezing plans to future benefit accruals, and engaging in pension risk transfers, either through direct lump sums to participants or transferring liabilities to insurance companies.
Those moves, however, require full funding which sometimes can require a large corporate contribution. Those kinds of contributions have not been necessary the last two years, for the most part. Expected contributions for 2024 among the 100 plans totals only $9.5 billion, down from $12.5 billion in 2022.
The health of corporate pension plans in 2023 was also helped by an improved investment return environment in both public equities and fixed income.
For the year ended Dec. 31, the Russell 3000 index and Bloomberg U.S. Aggregate Bond index returned 26% and 5.5%, respectively, a significant turnaround from their respective returns of -19.2% and -13% the previous year.
P&I’s universe of 100 plans accumulated $74.7 billion in actual return on plan assets in 2023, compared with accumulated losses of $245.7 billion in investment losses in 2022. The average discount rate dropped slightly to 5.18% from 5.25%.
As of Dec. 31, total fair value of plan assets was $1.072 trillion, down from $1.075 trillion a year earlier, while projected benefit obligations totaled $1.073 trillion, down from $1.075 trillion the year before.
Fixed income stabilizes funding volatility
Royce Kosoff, managing director, retirement at Willis Towers Watson, said the situation for corporate pension plans is far more stable than the last time they were fully funded on average.
“If you just look at all of the metrics, we can even start with asset allocation, for example,” said Kosoff. “This year was the 16th straight year where we saw a decline in (the allocation of) public equity and an increase in debt. It was with fixed income or debt, intended to in many cases match the liability movement, so companies are protected from those interest rate swings.”
As of Dec. 31, the average allocation to fixed income among the top 100 companies was 49.6%, according to P&I analysis. Fifteen years earlier, the average allocation to fixed income was 33.8%. Also, 51 companies had over 50% allocated to fixed income, up from 38 companies a year earlier.
Meanwhile, the average allocation to equities among the top 100 companies was 23.2% as of Dec. 31, compared with the average allocation of 48% 15 years earlier.
J.P. Morgan's Gross said that while he would “never say never” to a funding crisis in the future, the changes in asset allocation among corporate plans have made a crisis unlikely.
“There is always some ‘black swan’ event that might harm pensions, but it is becoming increasingly difficult to identify significant areas of risk for what I will call kind of the standard model of defined benefit allocation in 2024,” Gross said.
That standard model is a large customized hedged portfolio with a large portion allocated to assets designed to resemble liabilities, combined with a smaller portfolio of return-seeking assets that are diversified across both public and private markets, said Gross.
"That combination in aggregate delivers modest excess performance with a relatively low level of funding volatility," he said. “In any dimension of risk that you choose to look at, pension funds are materially safer than they have basically ever been before because the last time we were at these levels of funding, the asset allocation was riskier."
“So that combination of improved funding and derisked asset allocation has proven to be incredibly powerful at taking risk out of the system," he said.
Reopening DB plans
Now that more plans have surpluses, executives have more options than ever. One such option, at times unthinkable over the last two decades, is using pension surplus money to reopen a defined benefit plan.
International Business Machines Inc., Armonk, N.Y., shocked the institutional investing community when it announced its decision in November to reopen its defined benefit plan with a cash balance component. The company originally froze its defined benefit cash balance plan to future benefit accruals as of Dec. 31, 2007. Since then, the IBM 401(k) Plus Plan has been the primary retirement plan for active employees, and in 2022, the company contributed just over $489 million to the plan, according to its latest 11-K filing.
In November, IBM announced it was scrapping its 401(k) corporate match and replacing it with a cash balance component called a retirement benefit account. In all likelihood, IBM was spurred on to the decision by a very healthy funding surplus in its defined benefit plan. As of Dec. 31, 2022, the company reported a funding ratio of 116.8% in its 10-K filing.
IBM is the only company of its size to make such a bold move, but its significant visibility has spurred discussions by some plan sponsors.
