Strong recovery amid pandemic produces small gain in funding

Despite a 71-basis-point drop in the average discount rate contributing to a 7.7% rise in aggregate liabilities, Pensions & Investments' annual analysis of SEC filings showed a 1-percentage-point increase in the average funding ratio of the 100 largest U.S. corporate defined benefit plans in 2020.

"If you didn't know what happened in between, you wouldn't have seen too much change year-over-year from 2019 to 2020, with funded status ending right around where it started. But a lot did happen," said Tom Meyers, executive director and head of Americas client solutions at Aviva Investors Americas LLC in Chicago.

As of March 31, 2020, Wilshire Consulting estimated the aggregate funding level of S&P 500 company-sponsored pension plans at 79.2%, a 9.4-percentage-point decrease from the end of 2019. However, the aggregate funding ratio of P&I's universe was 88.4% as of Dec. 31, which Mr. Meyers said "reflects the magnitude of the capital markets recovery."

The average funding ratio of the 100 largest plans was 92%, up from 91% the year before.

As plans recovered from the drop in funded status and the market dislocations that followed the onset of the pandemic last spring, Mr. Meyers said well-positioned plans made opportunistic moves, such as selling Treasuries to increase corporate bond exposures at higher spreads and investing in alternative asset classes like commercial real estate, private credit or high yield that were under pressure during the crisis.

"Plans that had the ability and the governance in place to tactically invest, and the consultants to guide them there, did that," Mr. Meyers said.

The crisis period brought challenges, he said, but it also gave sponsors valuable perspective into their portfolios.

"It was an opportunity to almost view the world in terms of a full cycle within a very short period of time," he said. "What plan sponsors and consultants then had the ability to do was sit back in the fall and say, from a liquidity perspective or from a performance perspective, did my portfolio and the underlying managers do as we expected? We saw clients starting to make portfolio adjustments holistically, on the basis of the lessons learned through 2020, as a result of those observations."

The aggregate funding deficit increased 2.4% to $186.2 billion in 2020, while aggregate assets in P&I's universe rose 8.4% to $1.414 trillion, buoyed by an average return of 12.8%.

The Russell 3000 index returned 20.88% in 2020, the S&P 500 index had an 18.39% return and the MSCI World ex-U.S. index gained 7.59%.

In fixed income, the Bloomberg Barclays U.S. Long-Government Bond index ended 2020 with a 17.55% return. The Bloomberg Barclays U.S. Long-Duration Corporate Bond index gained 13.56%. The Bloomberg Barclays Global Aggregate ex-U.S. Bond index returned 10.11% and the Bloomberg Barclays U.S. Aggregate Bond index had a 7.51% return as of Dec. 31.

The Federal Open Market Committee cut the federal funds rate twice in March 2020, ultimately to the zero to 0.25% range.

The Federal Reserve established the Secondary Market Corporate Credit Facility on March 23 to provide stability and liquidity in the corporate bond market. In addition to buying investment-grade corporate bonds, the Fed also bought U.S.-listed ETFs, "to provide broad exposure to the market for U.S. corporate bonds," according to the Federal Reserve's website.

In an environment of lower interest rates, the average discount rate of the plans in P&I's universe fell to 2.59% at the end of 2020, from 3.3% one year earlier.

Zorast Wadia, the New York-based principal and consulting actuary and co-author of Milliman Inc.'s corporate pension funding study, said 2021 has started with an "almost perfect scenario" for the funded status of corporate plans.

"It's a win-win scenario for pensions because we've seen discount rates rise tremendously in the first quarter and assets seem to be holding pace," he said. "They are underperforming based on monthly expectations. But really, it's the discount rates that are carrying and really driving funded status."

Discount rates increased by 66 basis points in the first quarter of 2021, according to Milliman's April report.

"In 2020, rates dropped about 67 basis points for the whole year. So in a sense, the rise in interest rates that we've just experienced so far in the first quarter is reversing all of the interest rate activity that we experienced in 2020 and as a result, it's really boosted the funded status," Mr. Wadia said.

For the 100 plans that Milliman tracks, the average discount rate was 3.12% at the end of March, up 24 basis points from 2.88% in February. Milliman's report said this was the first time discount rates have exceeded 3% at month-end in the past year.

According to the report, liability gains during March improved the funded status by $62 billion and lifted the funding ratio to 98.4% as of March 31.

"One of the takeaways has been how the nature of interest-rate hedging portfolios can change as the fixed-income market changes, and you constantly need to be adjusting your fixed-income hedge," said Brian McDonnell, head of the global pension practice at Cambridge Associates LLC in Boston. "That really is not a 'set it and forget it' strategy, particularly in times of market volatility."

Mr. McDonnell said sponsors need to be aware of interest-rate moves along different parts of the yield curve to make sure the plan's hedge ratio is not moving in a counterintuitive direction.

Liquidity planning was another key lesson of 2020, he said, as plans balance their liability-matched fixed-income portfolios with less-liquid compound growth opportunities in private markets.

"If you're going to have a long-term investment strategy that is going to provide the compounding that underfunded plans need, that has to be complemented by very strong liquidity planning," Mr. McDonnell said. "How are you sourcing your capital for benefit payments in April or late March when everything is sold down? How are you sourcing benefit payments when planned contributions end up not having to materialize because there is a regulatory change?"

He said capital investment opportunities arose during the period of market dislocation in spring 2020, giving nimble plans the ability to upgrade managers and take advantage of a window in which some closed funds briefly opened to new capital.

Nimble sponsors were able to say, "we like the managers that we utilize, but there are two or three wish list, 'dream team' managers that have been closed to new capital for five or 10 years because of their capacity limitations, and they might open briefly during a market dislocation to allow new investors," Mr. McDonnell said.

Plans with an outsourced CIO or another delegated process that doesn't rely on meeting individually with managers had an advantage, he said, because those plans were able to act quickly when opportunities arose.

"I think any period like we've just had causes you to focus on what your core competencies might be, whether as a plan sponsor or an investment organization. I think from that perspective, this has been another example of nimbleness really being rewarded," Mr. McDonnell said.

A 14.5-percentage-point rise in the plans' funding ratio to 84.65% gave Unisys Corp. the largest increase in P&I's universe.

According to a 10-Q filing in October, the Blue Bell, Pa.-based information technology company announced plans to transfer about $1 billion in global pension plan liabilities through "a combination of bulk lump-sum buyouts, annuity purchases and other actions."

In January 2021, Unisys entered into an agreement to purchase a group annuity contract from Massachusetts Mutual Life Insurance Co. to transfer about $280 million in U.S. pension plan assets.

Unisys made a $793 million contribution to its defined benefit plans in 2020 and had a 9% return on assets. The plan ended the year with $4.55 billion in liabilities and $3.85 billion in assets.

An April 2020 merger of United Technologies Corp. and Raytheon Co. produced an 87.5% funding ratio for the new combined company, Raytheon Technologies Corp.

With $71.3 billion in liabilities and $62.3 billion in assets, Waltham, Mass.-based Raytheon Technologies Corp. made a $1.2 billion dollar contribution to its defined benefit plans and had a 15.9% return for the year ended Dec. 31.

At the end of 2019, United Technologies had a funding ratio of 94.9%, with $41.8 billion in liabilities and $39.7 billion in assets, while the former Raytheon Co. had a 73.5% funding ratio, with $29 billion in liabilities and $21.3 billion in assets.

For the 16th consecutive year, NextEra Energy Inc., Juno Beach, Fla., had the highest funding ratio in P&I's universe. With $5.3 billion in assets, $3.6 billion in liabilities and a 13.6% return on plan assets, NextEra's funding ratio rose to 147.3% in 2020, up from 142.7% at the end of the previous year.

Aggregate employer contributions across P&I's universe rose to $28.5 billion in 2020, up $2.4 billion from the previous year, as nine plans on the list contributed $1 billion or more to their defined benefit plans during the year.

The Boeing Co., General Electric and United Parcel Service Inc. made the largest contributions in 2020. A fourth-quarter contribution of $3 billion in common stock and a 13.5% return on assets helped raise Chicago-based Boeing's funding ratio to 83.4%, up from 79.5% at the end of 2019.

Boston-based GE contributed $2.8 billion to its principal U.S. plans and $509 million to its international and other plans in 2020. The company also transferred $1.7 billion of its U.S. GE Pension Plan obligation, representing the benefits of approximately 70,000 retirees and beneficiaries, through an annuity buyout in December with Athene Holding Ltd.

GE reported a 15.2% return, $58.8 billion in assets and $76.3 billion in liabilities as the funding ratio of GE's principals rose to 77.1% at the end of 2020 from 73.4% a year earlier.

Atlanta-based UPS saw its funding ratio fall to 80.4% in 2020 from 85.4% a year earlier despite an 11.1% return on plan assets and a $2.8 billion contribution to its DB plans. The plans ended the year with $65.9 billion in liabilities, up nearly $12 billion from $54 billion the year before, while assets increased to $53 billion from $46.2 billion.

UPS refined the bond-matching approach used to determine the discount rate for its U.S. pension plans to "enhance the simulation of bond portfolios that match the plans' expected cash flows and result in a better estimate of the plan discount rates," according to the company's 10-K filing.

As of Dec. 31, UPS estimates each 1-basis-point increase in the discount rate would decrease the projected pension benefit obligation by $110 million, while a 1-basis-point decrease would result in an increase of $118 million.

The discount rate fell 70 basis points for UPS to 2.9% in 2020 from 3.6% one year earlier.

The aggregate allocation to fixed income in P&I's universe continued its upward trend in 2020, rising 40 basis points over the year to 47.7%, while the aggregate allocation to equities rose slightly to 31%, up from 30.9% in 2019.

The aggregate allocation to alternatives fell 1 percentage point in 2020 to 15.4%, with the private equity allocation rising to 5.3% from 5.2% one year earlier.

Plans' real estate allocations, meanwhile, dropped to an aggregate 3.6% from 3.9% at the end of 2019, and hedge fund allocations fell 60 basis points over the year to an aggregate 2.7%.

The aggregate allocation to cash rose to 2.8% in 2020, up from 2.6% a year earlier.

Aggregate assets, liabilities and funded status rose for the 100 largest plans in 2020 as the average discount rate plummeted.