Companies’ U.S. pension plans are more overfunded than they
have been in years amid strong equity markets.
Those surpluses will likely go up further if long-term
corporate bond yields continue to rise, as many of these plans use those yields
to value their liabilities. That could prompt finance chiefs to revise their
pension strategies.
An estimated 40 of the largest 100 U.S. pension plans were
funded at 100% or more in 2021, the most since 2007, and up from 16 in 2020 and
13 in 2019, according to data from advisory firm Willis Towers Watson PLC. The
40 plans, all of them defined-benefit plans that promise fixed payouts to
retirees, were overfunded by a total of $45.49 billion last year, up from
$22.58 billion among the overfunded 16 plans in 2020, Willis Towers said.
Long-term corporate bond yields, also known as discount
rates in the pension world, increased to 2.76% at the end of 2021 from 2.32% at
the end of 2020, according to asset manager Mercer LLC’s calculation of what it
calls typical discount rates for pensions. The move up in those yields came
amid higher inflation and expectations the Federal Reserve would start moving
away from its pandemic stimulus and near-zero policy rate.
Discount rates are forecast to continue their upward climb
this year, which would push up funding levels even more, as the Federal Reserve
signals its intention to raise interest rates. Higher interest rates mean
companies need to set aside less in the way of assets to fully fund pension
obligations because the present value of future payments shrinks.
Funding levels of corporate pension plans have soared since
the early stages of the coronavirus pandemic in the spring of 2020, when they
fell compared with the prior-year period. Defined-benefit plans had an
aggregated funding status of 96% at the end of 2021, up from 88% a year
earlier, according to WTW’s review of 361 Fortune 1000 companies.
Funding levels in excess of 100% allow companies to further
reduce financial risks stemming from their pension obligations—for example, by
purchasing annuities, terminating their plan or switching to more conservative
investments such as fixed-income securities. An increase in funding also
provides breathing room for plans that are below 100%.
However, overfunded pensions could become underfunded again
if market declines reduce pension asset values, corporate advisers said.
Roughly 60% of Fortune 1000 companies’ defined-benefit plans remain in deficit,
Willis Towers data showed.
Truist Financial Corp. , a Charlotte, N.C.-based bank
holding company, is allocating more funds to fixed-income assets such as U.S.
corporate bonds and U.S. Treasurys to reduce risks in its plans, Chief
Financial Officer Daryl Bible said. “The more investments you have that are
earning, it basically lowers the cost of adding to the pension,” he said.
The company, which was created when BB&T Corp. and
SunTrust Banks Inc. merged in 2019, combined two sets of defined-benefit plans.
Truist’s plans were funded at 133.8% in 2020, up from 132.2% in 2019, according
to consulting firm Milliman Inc. Truist’s projected pension liabilities were
$10.35 billion at the end of 2020, compared with a combined $6.07 billion in
2019, it said.
The company’s plans cover about 106,800 people, including
current employees and retirees. They continue to admit new members, which is
contrary to many other defined-benefit plans that are closed to new entrants.
Many companies in recent decades have moved new hires to 401(k) plans because
of the continuing obligations that defined-benefit plans carry.
Companies can benefit from funding their plan beyond 100%. A
pension surplus can provide protection from future market volatility, which
could drag down the funding level, and allow companies to continue offering
pension benefits to employees without having to make contributions, said Beth
Ashmore, a managing director at WTW. “There still is some value in having a
little bit more surplus on the balance sheet,” Ms. Ashmore said.
Media and education company Graham Holdings Co. ’s pension
plan had $3.2 billion in pension assets and about $1.1 billion in pension
liabilities as of Sept. 30. The Arlington, Va.-based company is assessing its
options for using its surplus pension assets, such as transferring assets from
a plan closed to new entrants to a qualified replacement plan—a different type
of defined-contribution plan—CFO Wallace Cooney said last month on a call with
analysts and investors. That would reduce the company’s cash spending on
retirement benefits, Mr. Cooney said.
“There simply are not that many playbooks out there for
exactly how to best manage our overfunded pension,” Mr. Cooney said on the
call. A spokeswoman for the company declined to comment further.
Companies shouldn’t push a plan’s funding far beyond 100%
and make riskier investments that could cause a funding shortage—for example,
in certain equities, real estate and other assets, said Matt McDaniel, a
partner at Mercer. “If you go from 110% funded to 90% funded, that becomes
pretty painful and you’ve got to start putting cash back in,” Mr. McDaniel
said.
Under U.S. law, companies whose plans are more than 120%
funded under federal calculations are allowed to use the excess funds for other
purposes, such as retiree health benefits. Funding levels for federal funding
requirement purposes are calculated differently from those in financial
statements.
Some businesses also use their surplus to provide additional
pension benefits instead of severance-related payments, said Paul Rangecroft,
who heads up the wealth solutions practice at professional-services firm Aon
PLC.
Executives generally avoid cashing out a portion of their
pension surplus after terminating a plan because assets that don’t go toward participants’
benefits are subject to a 50% excise tax as well as federal and state income
taxes, Ms. Ashmore said.
Companies with well-funded plans in recent months have
increased their efforts to reduce investment risks associated with them. For
example, plan sponsors are increasingly shifting their pension obligations into
annuities, which they purchase from an insurer for all or some of their
employees with vested benefits. Annuitizations shrink a plan’s assets and
liabilities and simultaneously strengthen a company’s balance sheet by removing
the pension obligation.
U.S. businesses spent an estimated $37 billion on
annuitizations in 2021, up from $26.8 billion the previous year, Mercer data
showed. The figure represents the pension assets transferred to cover the
annuity.
Meritor Inc., a Troy, Mich.-based auto-parts maker, plans to
annuitize its U.K. plan, which is overfunded at about 130%, in the next 12 to
24 months, CFO Carl Anderson said. It would then look to do a similar deal
involving its U.S. plan—which is funded at about 92%—possibly in four to five
years, he said. The company’s U.S. and U.K. plans were roughly 70% funded as of
2011. Meritor boosted them through contributions and investments, Mr. Anderson
said.
“We’ve come a long way, really, since the financial crisis,”
he said.
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