Pension funded status at highest in 10 years (despite pandemic)

The increase in interest rates seen in 2022 has improved pension funded status and provided attractive yields for sponsors wanting to de-risk by increasing their allocation to fixed income, according to a new report.

A decade of volatile stock markets, including markets during a once in 100-year pandemic, reveals growth in U.S. corporate pension funded status. MetLife Investment Management (MIM), the institutional asset management business of MetLife, estimates that as of Nov 7, 2022, the average U.S. corporate pension funded status rose to 106.3% — the highest in 10 years. The quarter-end average was 104.7%, which is 4.0% above the end of the second quarter.

“The increase in interest rates seen in 2022 has improved pension funded status and provided attractive yields for sponsors wanting to de-risk by increasing their allocation to fixed income,” said Stephen Mullin, head of Long Duration and LDI strategies at MIM. Furthermore, according to Jeff Passmore, LDI Strategist, “asset returns outpaced liability increases resulting improved funded status during the fourth quarter.”

Related: Pension plans hold steady at 95% funded status (despite challenging year)

MIM says that pension liabilities have increased due to the passage of time and benefit accruals. Discount rates fell by four basis points with spread tightening offset by increases in long-term interest rates. Benefit accruals decreased funded status by just 0.5% and interest cost decreased funded status by 0.7%. However, asset returns resulted in a 5.2% increase in funded status of which stocks represented 3.3%, bonds 1.1%, and alternatives 0.7%.

Predicting the future, however, is difficult and the move of the Fed is uncertain at this point. Says Passmore: “It’s difficult to call the direction and timing of interest rate movements. Rate prognosticators, the Fed and even future rates implied by the forward curve are notorious for being wrong as often as they are right. All our fixed income strategies are duration neutral; we find security selection to be a more consistently rewarded source of excess returns.”

Given that liabilities are down and funded status is at all time highs, however, “we expect continued interest in liability hedging strategies,” adds Passmore. “Over time these have evolved from Long Gov/Credit, to Long Credit and now often include allocations to Intermediate Credit and STRIPS.  We’re also seeing interest from plan sponsors in LDI overlays, both with physicals and derivatives.”