The past few years have seen an increase in the number of companies with overfunded pension plans, meaning they will be able to pay out more than they owe. This comes as a result of a variety of factors, including higher stock prices and less volatility overall.
A company’s U.S. pension plan is more overfunded than it has been in years, according to the latest annual report on the plans. There are a number of reasons for this change, including lower interest rates and increased contributions from companies.
Due to robust equities markets, company pension plans in the United States are more overfunded than they have been in years.
If long-term corporate bond rates continue to increase, those surpluses will likely grow much more, since many of these plans utilize those yields to evaluate their liabilities. Finance executives may be prompted to rethink their pension plans as a result of this.
According to statistics from consultancy company Willis Towers Watson PLC, 40 of the top 100 U.S. pension plans were fully funded in 2021, the highest since 2007. This is up from 16 in 2020 and 13 in 2019. Willis Towers said that the 40 plans, all of which are defined-benefit plans with set payments to retirees, were overfunded by a total of $45.49 billion last year, up from $22.58 billion among the 16 overfunded plans in 2020.
According to asset management Mercer LLC’s computation of what it terms average discount rates for pensions, long-term corporate bond yields, also known as discount rates in the pension sector, jumped to 2.76 percent by the end of 2021 from 2.32 percent at the end of 2020. Higher inflation and anticipation that the Federal Reserve will begin to move away from its massive stimulus and near-zero policy rate pushed those yields higher.
As the Federal Reserve expresses its desire to increase interest rates, discount rates are expected to rise further this year, pushing up financing levels even further. Because the current value of future payments reduces when interest rates rise, corporations must put aside less in the form of assets to adequately meet pension obligations.
Subscribe to our newsletter
CFO Journal | WSJ
The CFO Journal team delivers daily news and perspectives on corporate finance in The Morning Ledger.
Since the early phases of the coronavirus pandemic in the spring of 2020, when funding levels declined compared to the previous year, corporate pension plan funding levels have skyrocketed. According to WTW’s study of 361 Fortune 1000 businesses, defined-benefit plans had an aggregated funding status of 96 percent at the end of 2021, up from 88 percent a year earlier.
Companies with funding levels over 100% may take steps to mitigate the financial risks associated with their pension obligations, such as buying annuities, dissolving the plan, or moving to more conservative assets like fixed-income securities. An boost in financing also gives proposals that aren’t fully funded breathing space.
Overfunded pensions, on the other hand, might become underfunded again if market losses lower pension asset prices, according to company advisors. According to Willis Towers statistics, around 60% of Fortune 1000 businesses’ defined-benefit plans are still in deficit.
Chief Financial Officer Daryl Bible of Truist Financial Corp., a Charlotte, N.C.-based bank holding company, said the business is allocating more money to fixed-income assets such as US corporate bonds and US Treasurys to decrease risks in its plans. “The more earning assets you have, the lower the cost of contributing 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.
About 106,800 individuals are covered by the company’s programs, including current workers and retirees. In contrast to many other defined-benefit plans that are closed to new members, they continue to accept new members. Because defined-benefit plans entail ongoing commitments, many firms have switched new recruits to 401(k) plans in recent decades.
Companies may profit from financing their plans at a higher level than 100%. According to Beth Ashmore, a managing director at WTW, a pension surplus may insulate firms against future market volatility, which might reduce funding levels, and enable companies to continue giving pension benefits to workers without having to make payments. “Having a little bit more excess on the balance sheet still has some benefit,” Ms. Ashmore said.
As of Sept. 30, the pension plan of Graham Holdings Co., a media and education corporation, had $3.2 billion in assets and nearly $1.1 billion in liabilities. CFO Wallace Cooney said last month on a call with analysts and investors that the Arlington, Va.-based company is evaluating its options for using 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. According to Mr. Cooney, this would cut the company’s financial outlay on retirement benefits.
On the call, Mr. Cooney added, “There aren’t that many playbooks out there on precisely how to effectively handle our overfunded pension.” The company’s spokesperson refused to speak more.
According to Matt McDaniel, a partner at Mercer, companies should not push a plan’s financing beyond 100% and make riskier investments that might result in a funding deficit, such as in particular stocks, real estate, and other assets. “When you go from 110 percent to 90 percent financed, it’s quite unpleasant, and you have to start putting money back in,” Mr. McDaniel said.
Companies that have plans that are more than 120 percent funded according to federal calculations are allowed to use the excess funds for other purposes, such as retiree health benefits, under US law. The funding levels used to meet federal funding requirements vary from those used in financial statements.
According to Paul Rangecroft, head of the wealth solutions department at professional services company Aon PLC, some organizations utilize their excess to give extra pension benefits instead of severance-related payments.
According to Ms. Ashmore, executives often avoid cashing out a portion of their pension excess after ending a plan since assets that don’t go toward participants’ benefits are subject to a 50 percent excise tax, as well as federal and state income taxes.
In recent months, companies with well-funded plans have stepped up their attempts to lessen the financial risks linked with them. Plan sponsors, for example, are increasingly converting their pension liabilities into annuities, which they buy from an insurer for all or portion of their vested workers. By reducing the pension obligation, annuitizations reduce a plan’s assets and liabilities while also strengthening a company’s financial sheet.
According to Mercer statistics, corporations in the United States spent $37 billion on annuitizations in 2021, up from $26.8 billion the previous year. The graphic depicts the transfer of pension funds to cover the annuity.
Meritor Inc., located in Troy, Mich., aims to annuitize its U.K. plan, which is 130 percent overfunded, in the next 12 to 24 months, according to CFO Carl Anderson. He said that it will then attempt to negotiate a similar transaction with its US plan, which is financed at roughly 92 percent, in four to five years. As of 2011, the company’s ambitions in the United States and the United Kingdom were around 70% financed. Meritor aided them with donations and investments, according to Mr. Anderson.
“Since the financial crisis, we’ve gone a long way,” he remarked.
Mark Maurer can be reached at [email protected]
Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8
The “cash balance plan” is a type of pension plan that allows employers to invest their employee’s contributions in the company’s cash balance. Companies’ U.S. Pension Plans are more overfunded than they have been in years, which could be an indicator that the market is improving.
Frequently Asked Questions
What might have been the primary reason for the pension plan becoming overfunded?
What happens when a pension plan is overfunded?
A: When a pension plan is overfunded, it means the liabilities of its members have exceeded the assets that can be used to cover those liabilities. The results are typically bankruptcy for both individuals and companies who participate in these plans, or an increased risk of total collapse.
What determines whether a pension plan is underfunded or overfunded?
A: If a pension plan has gains and losses, the fund is underfunded.
Related Tags
- unfunded pension liabilities
- how to fix underfunded pensions
- an overfunded pension plan means that the quizlet
- what pensions are not taxable?
