Pension Plan Funding and Key Factors to Watch

 

The ripple effects of economic developments and interactions touch many shores—including pension plans. Recent studies discuss factors now affecting plans as well as what developments may portend. 

 

 

Insight Investment, in its quarterly U.S. Pension Market paper, reports that the funded status of all three of the pension indices they track improved in the third quarter. The three indices they maintain are a liability-drive investment (LDI) pension index, which reflects plans that have adopted LDI in the fixed income portion of their portfolio; a traditional pension index, which reflects plans that have not yet adopted LDI; and a Large Company Aggregate Pension (LCAP) Index, which aims to represent an asset weighted average of allocations held by S&P 500 companies’ plans.

 

The funded status of its traditional index, which has no investments in long-duration fixed income, improved to 93.8% in the third quarter; the improvement in the funded status of the LDI and LCAP indices was even greater, says Insight Investment, taking them to 102.3% and 100.2% respectively. Further, says Insight Investment, the funded status of all three indices has improved for the year so far as well, by roughly 10%.

 

October Three, which tracks two hypothetical defined benefit plans—one that is invested in a more traditional way and another invested in a conservative manner—reports that pension plan funding improved in September; in addition, it reports that funding remains up for 2021. “Generally, plan funding statuses in 2021 have improved,” says the report.

 

 

U.S. annuity sales totaled $62.2 billion in the third quarter, the Secure Retirement Institute (SRI) says in preliminary results from its U.S. Individual Annuity Sales Survey. SRI says that represents sales 12% higher that those of the third quarter of 2020. So far for the year, they say, annuity sales increased 19% to $191.4 billion. SRI says that those sales are the highest in the first nine months of a year since 2008. 

 

SRI also examined sales of different kinds of annuities:

 

 

October Three reports that annuity purchase costs for retirees have “consistently been between 98% – 104% of the pension accounting value” and that purchase costs have fallen slightly.

 

In looking at annuity sales and trends, October Three measures the performance of two annuity plans: Annuity Plan 1 serves all retirees and has a duration of seven years and Annuity Plan 2 serves both retirees and those who are still making deferrals, although a strong majority are retirees (70% and 30%, respectively). They report that in September 2021, the spread between pension risk transfer price and GAAP and projected benefit obligation (PBO) for Annuity Plan 1 is 3.56% and the spread for Annuity Plan 2 is 9.38%. In September, the annuity purchase price for Annuity Plan 1 decreased 0.50% and Annuity Plan 2 decreased 0.82%. Overall for 2021, October Three says, “significant month-to-month cost volatility has persisted.” 

 

 

Insight Investment also looks at what lies ahead. Key risks, the paper says, include “stickier than expected inflation, forcing a more disruptive response from the Fed, and pressure on corporates to increase leverage in the low-yield environment, leading to credit downgrades and greater financial risk.” 

 

The paper says that inflation “has so far been dominated by ‘volatile’ rather than ‘sticky’ categories,” and adds that factors such as the delta variant have exacerbated inflation. They expect that in the fourth quarter of 2021, inflation will be among the key market risks for pensions and that it will become “more sustained than transitory.” 

 

The paper cites what it calls the “unprecedented pace” of the growth in the Federal Reserve’s balance sheet as a catalyst for concern that this “could create significant inflation or that tapering could spark significant, sustained market volatility.”  

 

Insight Investment suggests that higher inflation will “give the more hawkish members of the Federal Open Markets Committee (FOMC)—the branch of the Federal Reserve System that determines the direction of monetary policy specifically by directing open market operations—a greater voice for now.” Those members, it says, want to “reduce the excess liquidity that has flooded the system.” They do not anticipate that this will last, however; nor do they consider it likely that significant inflation or greater market volatility will result from the Federal Reserve’s activity, in light of the mechanisms in its asset purchase programs. 

 

The paper expresses the expectation that pension liabilities will shorten due to corporate pension plans becoming increasingly closed to new members. As this happens, it argues, pension investments likely will “shift towards slightly lower-duration assets.” This, they say, would support the intermediate section of the corporate bond curve and also could support lower duration fixed income sectors, among them high-yield credit and structured credit.

 

October Three says that as some insurers begin to hit capacity restraints, it expects a high level of pension risk transfer activity and insurance company competition to be more prevalent as the year goes on.