Good News for Large Pensions
A defined benefit plan’s funded status is often cited as an indication of the plan’s financial health and there is good news on that score for the largest U.S. plans. A report from Willis Towers Watson shows that the estimated aggregate funded status of 361 Fortune 1000 companies improved to 96% at the end of 2021. That’s the highest level since 2007 and an increase of five percentage points from 2020. The analysis also found the funding deficit is projected to be $63 billion at the end of 2021, significantly less than the $232 billion deficit at the end of 2020. Pension obligations decreased 8% from $1.89 trillion at the end of 2020 to an estimated $1.74 trillion at the end of 2021.
According to Jennifer Lewis, senior director—retirement with Willis Towers Watson, the main drivers of funded status improvement in 2021 were rising interest rates used to determine plan obligations and strong investment returns. According to the analysis, pension plan assets increased slightly (1%) in 2021, finishing the year at $1.67 trillion. Overall investment returns are estimated to have averaged 8.9% in 2021, although returns varied by asset class. Domestic large-cap equities grew 29%, while domestic small/mid-cap equities saw gains of 18%. Aggregate bonds recognized losses of -2%, while long corporate and long government bonds, typically used in liability-driven investing strategies, realized losses of -1% and -5%, respectively. Other factors: Asset growth was limited by a record year in pension risk transfers and lower-than-average cash contributions.
The positive factors might not provide the same boost in 2022, Lewis notes: “In the first two months of 2022, the economic factors have moved in opposite directions. Interest rates continue to rise, while equity returns were negative or near zero. Political and macroeconomic factors could weigh heavily on results in the near-term.”
As the report stated, pension risk transfers had a record year. One possible consequence of their improved funded status is that more plans will consider these transfers to offload part or all of their plan liabilities. “We expect some plan sponsors who have better positioned their plans to withstand market risk will continue to move forward with planned actions,” says Lewis. “This includes some frozen plans considering or executing full plan terminations.”
Not So Good News for DC Plans
On March 1, Morningstar subsidiary Morningstar Investment Management LLC’s Workplace Solutions group announced the formation of the Morningstar Center for Retirement and Policy Studies. The center’s first issue brief, Retirement Plan Landscape Report by Aron Szapiro and Lia Mitchell, examines four aspects of the U.S. retirement system, including: trends across coverage, assets and numbers of defined-contribution plans; costs to workers and retirees within these plans, as well as their investments; the kinds of investments held by these plans; and the continued role of defined-benefit plans for today's retirees.
The report highlights several key findings:
- Defined contribution plans saw a $4.61 trillion outflow of money from 2011 to 2020. These outflows, which the authors believe are likely due mostly to rollovers and cash-outs, reduce plan assets, which in turn leads to higher asset management fees and lower returns for participants.
- Plan costs vary widely, with some participants in small plans paying around double that of participants at larger plans. The authors note that “these differences in fees can add up, leaving participants with fewer assets at retirement and less ability to achieve their retirement goals.”
- Plan sponsors appear to have shied away from considering environmental, social and governance (ESG) information and analysis, in part because of regulatory uncertainty. The report contends that this avoidance has exposed the U.S. DC system to greater ESG risk, defined as “the degree to which companies fail to manage ESG risks, potentially imperiling their long-term economic value.” The authors’ advice: Plan sponsors may wish to reexamine their investment choices using an ESG lens.
Given the success of 401(k) plans in at least partly replacing DB plans, I suspect many of us have an optimistic outlook on the U.S. retirement system. But the authors believe that optimism might be ill-founded. Per the report: “At first glance, the U.S. retirement system appears to be stable, but that obscures the fragility of a system that loses thousands of plans and billions of assets every year. … A few years of poor returns would reduce many plans’ assets, their market power, and thus their capacity to offer institutionally priced investment options.”
That’s not the most upbeat news, but it's a well-documented, thought-provoking report that’s worth reading.