Fully Funded Pensions?

An recently released report found that, overall, corporate pensions were in strong financial shape in 2023 despite a challenging and dynamic macro environment.

Among the most notable findings of the Prudent Pensions Report, which is published annually by global investment solutions firm Russell Investments, was that 97 percent of corporate pensions are on track to achieve full funding, without a significant draw on corporate cash, within the next 10 years. That marks a sharp boost from 2022, when the figure was 86 percent. The report is the result of the analysis of approximately 500 pension plans in the U.S. large-cap Russell 1000 Index, based on the firms’ latest disclosures as well as market and interest rate movement in 2023.

Michael Hall, managing director, Americas Institutional, at Russell Investments, said full funding is attainable for most corporations in just a few years’ time, whether through a small increase in contributions or a small increase in returns.

“Corporate pensions are in better shape than they have been in years,” Hall said.

Drilling down into the report’s results, Hall said that 62 percent of companies’ pension plans will be fully funded in less than 10 years with an annual pension contribution rate of just 1 percent of cash flow from operations, keeping all other factors constant. An additional 35 percent will be fully funded in under 10 years at a 3 percent to 5 precent contribution rate. The report considers the past decade for perspective. In 2012, at a 5 percent contribution rate, 78 percent of plans required more than 10 years to achieve full funding. In the 2023 report, that number dropped to just 2 percent.

Of the 500 pension plans reviewed, only 10 would need to contribute 20 percent or more of their cash flow from operations to achieve full funding in 10 years. In addition, the percentage of companies in challenging or very challenging situations declined from 14 percent in 2022 to just 4 percent in 2023.

“This small minority of plans have historically driven the narrative, creating the continued false perception that the majority of corporate pension plans are in crisis,” Hall said.

For companies in the “healthy” band on the report’s Funded Status Health Check scale (those that can achieve full funding with a contribution rate of 5 percent or less), an extra 5 percent in asset contributions would cut their years-to-full-funding burden down from multiple years to just one. In this scenario, companies in the “challenging” band (those that can achieve full funding with a contribution rate of between 5 percent and 10 percent) would also see drastic improvements in funding.

“For many, this doesn’t change their prospects much from year to year”—i.e., whether they are in really bad shape or really good shape, Hall said. “For some, it does, and for those in this camp, when they find themselves in a favorable [healthy] position, being opportunistic risk managers makes a lot of sense. A little extra return makes a big difference for many as well, so knowing how your particular circumstance stacks up is important.”

Among the notable developments in pension plans in 2023 was IBM’s announcement that it would be shifting to a hybrid pension plan, which it is calling a retirement benefit account. The company will put 5 percent into an employee’s account, which will pay 6 percent interest through 2026. After that, the account will earn a rate equivalent to the 10-year U.S. Treasuries yield, with a 3 percent minimum per year through 2033. Hall said IBM’s decision warrants watching closely, though it is too early to see if it will influence other companies.

“The [defined-benefit] surplus provided an interesting way to finance contributions to associate financial well-being in retirement,” Hall said. “It will be interesting to see how long that persists [i.e., how long the surplus remains]. As to whether it fits into a larger trend about pension plans, I think we will need to wait two to three years.”

Looking ahead to next year, Hall said Russell will be taking a close look at some companies that experienced systemic surprises in 2023 to see how they react. For instance, he said, Russell will see whether companies that saw a large improvement in their situation in 2023 will be able to lock in that advantage in 2024.

Hall said the year-over-year improvement in the 2023 report’s results can be attributed to the sharp increase in interest rates. When rates rise and assets fall less than liabilities, funded status improves. If the Fed significantly cuts rates in 2024, the prospect for a trend reversal could increase.

“We believe it’s prudent to consider increasing contributions in the short term, while cash flows are up, to ensure greater stability,” Hall said. “Our data also demonstrates that, for some companies, there are more avenues to reducing a funded-status burden than just contributions. A prudent contribution rate and a prudent investment policy are key to achieving full funding, with limited impact on cash flows.”

From: BenefitsPRO