Here we are at the midpoint of a year with some interesting twists in the pension world, which may evolve into more material and persistent changes. Let’s review how far we’ve come, and then consider where that might lead.
It may be worth remembering, however, that we’ve seen many twists before. And we’ve found that it can take a lot to shift the direction of a large, slow moving machine: Changes don’t necessarily happen overnight.
Reviewing investment and pension fund metrics for the first half
Treasury yields are up for the year, creating negative bond returns and negative liability returns. Corporate bonds returns are less negative than their counterpart Treasurys given narrowing spreads over the first part of 2024. In the meantime, equity returns have been healthy.
Year-to-date index total returns as of 6/30/2024
Source: Parametric data as of 6/30/2024. For illustrative purposes only. Past performance is not an indicator of future results. It is not possible to invest directly in an index. Indexes are unmanaged and do not reflect the deduction of fees or expenses.
How are corporate pensions doing so far this year based on that information? As you might guess, funding ratios and surpluses have increased. According to Milliman 100 Pension Funding Index measures through the end of May, the surplus has risen from -$6.206 billion to $42.708 billion in 2024, and the funding ratio from 99.5% to 103.4%.
Pension plan funding ratios, 2000–2024
Source: Milliman data as of 5/31/2024. For illustrative purposes only. Past performance is not an indicator of future results. It is not possible to invest directly in an index. Indexes are unmanaged and do not reflect the deduction of fees or expenses.
Meanwhile, in the pension risk transfer (PRT) world, we’ve seen buyouts at a record pace driven by Verizon with a $5.9 billion buyout and Shell with a $4.9 billion buyout, both in the first quarter. There’s been activity in the second quarter, too, with a $2.5 billion buyout for 3M. We suppose this isn’t too surprising, given higher funding ratios, but the size of these buyouts is obviously rather large.
Pension buyout sales through Q1 2024
Source: LIMRA data as of 3/30/2024. LIMRA is an international association that conducts market, consumer, economic, financial, workforce and human resources research for life insurance and financial services companies, including risk management for pension plans. For illustrative purposes only. Past performance is not an indicator of future results. It is not possible to invest directly in an index. Indexes are unmanaged and do not reflect the deduction of fees or expenses.
Refine and enhance liability-driven investing strategies
Considering liability-driven investing trends
Higher yields, lower liabilities, strong equity returns, pensions in surplus position and an increase in buyouts—we’re all getting pretty used to this routine by now. Will these trends continue? Do they need to continue? Let’s try thinking ahead.
In the shorter term, looking forward, we see no reason to expect that anything will dramatically change. Again, shifts in the corporate pension world rarely occur overnight. Don’t fall asleep, though, as there are always things to be done.
For example, a sponsor could reevaluate their hedging strategy. If a plan isn’t well-hedged, beware—yields could fall, which might erase the funding gains of the past couple of years. Further, we believe it’s a potentially favorable environment for fixed income, where Treasury yields may come down and corporates are still offering value in spite of narrow spreads. Remember, if a plan is properly hedged against interest rates, then little harm can come from simply hibernating the plan and letting it run until conditions are favorable for a full plan termination (partial terminations can be a different story).
In the longer run, other factors may influence this decision. Earlier this year we saw a couple of interesting twists, which are still worth watching as time goes on:
Surplus pension assets
Our 2024 outlook discussed a large technology company reopening its plan to take advantage of a surplus, helped along by high equity returns and higher yields in the markets. A number of plans find themselves in this happy world right now, so they have to decide what to do with surplus pension assets.
Years ago, before LDI strategies became commonplace, the pension world tended to overlook risk management. Now, by taking steps to manage risks, pensions may use that surplus and future contributions to cover liabilities more predictably and cost-effectively in a reopened plan. That could help to provide stable benefits for participants, which would be a win for both plan sponsors and employees participating in the plan.
PRT legal actions
Another new development in 2024 is pension participants taking legal action against plan sponsors who have participated in pension risk transfers (PRT)—that is, purchasing annuities and shifting responsibility to an insurance company.
The claim is that the plan sponsor breached its fiduciary duty by failing to choose the safest insurer (with caveats) and that they paid the insurer more than reasonable compensation. The participants say those actions reduced the value of their benefits.
We’ll have to wait and see how far these actions get. In the meantime, risk mitigation strategies can be implemented with appropriate levels of sophistication depending on the plan—no matter whether it’s open, closed or reopened.
The bottom line
Amid twists in the pension world, we believe in watching market signs, viewing the pension plan as a whole and avoiding as much surplus risk as possible—particularly when taking on more risk isn’t needed to close funding ratios.
While the seeds for a new direction have been planted, it could take time for a more general shift among corporate pensions. Until a plan sponsor is ready to reopen a plan, we think it may be best to hold onto a hibernating position. Until the entire plan can be terminated in a buyout, we would implement an asset portfolio that seeks to limit interest rate risk, while maintaining appropriate levels of risk to promote growth.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.
