Robust voluntarycontributions, made as sponsors sought to write them off againstthe previous corporate tax rate and before rising rates to thePension Benefit Guaranty Corp. variable premiums set in, maskedwhat would have an even worse fourth quarter for pensions. (Photo:Shutterstock)

The average funded status for corporate defined benefit retirement plans peaked at 91percent by the end of September last year, bolstered by strongyear-to-date gains in equity markets and a wave of employers'voluntary contributions in light of cuts to corporate taxrates.

That marked a 5 percent increase in plans' funded status fromthe end of 2017, a 10 percent increase since 2016, and the highestlevel of pension funding seen since the financialcrisis, according to a report from Goldman Sachs AssetManagement.

But by the close of 2018, estimates of pension fund performance by GSAM show the year's gainswere lost, as the average funded ratio fell to 85 percent, slightlybelow where it began the year, writes Mike Moran, senior pensionstrategist for GSAM.

“Volatility is a reminder of the importance of a stronggovernance structure and the need to be nimble,” Moran said.

A handful of early filings—most plans will officially filepension funded status with the Securities and Exchange Commissionby the end of February—show some plans were able to lock in earlier2018 gains as they move considerable assets to fixed income.

When a complete picture of filings arrives, Moran suspects itwill show many other pension sponsors failed to lock in gainsbefore equity prices and interest rates fell in the fourthquarter.

“The opportunity to lock in such gains is often fleeting, andunfortunately the volatility in the fourth quarter demonstratedjust how fleeting it can be,” writes Moran.

How sponsors allocate assets, hedge risk, contribute to plans,and what they pay out in benefits will determine an individualplan's 2018 outcome.

But that variance in plan experience nevertheless underscoresthe need for a strong governance structure, says Moran.

Robust voluntary contributions, made as sponsors sought to writethem off against the previous corporate tax rate and before risingrates to the Pension Benefit Guaranty Corp. variable premiums setin, masked what would have an even worse fourth quarter forpensions.

GSAM estimates the average funded ratio benefited from a nearly4 percent increase in voluntary sponsor contributions.

Early anecdotal evidence of some plans locking in gains

The sponsors that were successfully able to lock in equity gainsfrom the first three quarters of the year won't befully tallied until full filings are made, GSAM's reportnotes.

Preliminary evidence shows some were successful in locking ingains. A spike in demand for U.S. Treasury Strips—securities soldat a discount because they don't pay interest—was seen in 2018.

Pension plans are “natural buyers” of Treasury Strips for theirduration characteristics, writes Moran. “We believe that much ofthe increase in stripping activity was due to demand from UScorporate pension plans.” The value of purchased Treasury Stripsincreased $60 billion in 2018.

Other evidence from intra-year or off-calendar year filings withthe SEC shows some plans made aggressive allocation moves tofixed-income prior to the fourth quarter's swoon in equities.

Honeywell's $19 billion plan increased its allocation to fixedincome by 12 percent, to 50 percent of the plan, in the firstquarter of 2018; Conagra's $3.4 billion plan increased itsfixed-income allocation from 25 percent of plan assets to 58percent in May; Johnson Controls' $3 billion plan increased itsallocation from 38 percent to 50 percent, according to GSAM'sreport.

Expected trends in risk transfer, LDI strategies for the2019

Gains in the first three quarters in 2018 motivated what isexpected to be another banner year for the pension risk transfermarket. Data from LIMRA and GSAM estimates 2018 sales of transferannuities was $21 billion, which would be the second highest levelof sales recorded since 2012's record $36 billion year.

Moran expects sponsors that have already tapped the annuitymarket will consider returning going forward. Scheduled increasesin PBGC's flat rate premium, which is assessed based on the numberof participants in a pension plan, will motivate more buyouts, hewrites.

Moran expects these trends will emerge as 2019unfolds:

1. Structuring an LDI portfolio may be more challenging

Liability Driven Investment strategies pair a pension's assetsto its liabilities, placing a greater imperative on fixed-incomeallocations to reduce the volatility of a plan's funded status.

But a tightening supply of investment grade corporate bonds, andthe availability of corporate debt shrinking in some industries,will challenge the implementation of LDI strategies. Sponsors maybe forced to incorporate lower rated BBB bonds.

“This all suggests a more challenging environment to constructan LDI portfolio and highlights the potential benefits of engagingan active LDI manager with experience in constructing appropriateportfolios. It may also lead some sponsors to contemplate otherasset classes outside of corporate credit that may be utilized aspart of a liability hedging program,” said Moran.

2. Risk transfer of active employees

Most of the risk transfer deals to date have been used to movethe liability of retired participants off sponsors' books.

But Moran sees evidence that more sponsors and insurers will bewilling to consider more expensive deals, at least in terms ofpremium, that include existing employees and terminated vestedemployees. “Transactions that expand out to include more activesand TVs may be the next wave, whether it involves a full plantermination or not,” says Moran.

3. De-risking equity in LDI strategies

Even as more sponsors move to greater allocations offixed-income, addressing volatility in remaining allocations ofequities will be an increasing focus of sponsors, thinks GSAM.

Recent market volatility is generating interest in defensive andlow volatility equity strategies. More sponsors are alsoconsidering alternative risk, hedge fund replication, andderivative strategies.

4. Holding more cash

Notwithstanding aggressive voluntary contribution strategies oflate, most plans are cash-flow negative, as they pay out more inbenefits than they get from cash infusions.

That reality will continue for many plans, as their workforcematures to retirement. That could argue for sponsors to hold morecash to avoid liquidating investments at inopportune times, saysMoran. Moreover, cash has the potential to become a strategic assetfor pensions as yields rise.

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