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

That marked a 5 percent increase in plans' funded status from the end of 2017, a 10 percent increase since 2016, and the highest level of pension funding seen since the financial crisis, according to a report from Goldman Sachs Asset Management.

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

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

A handful of early filings—most plans will officially file pension funded status with the Securities and Exchange Commission by the end of February—show some plans were able to lock in earlier 2018 gains as they move considerable assets to fixed income.

When a complete picture of filings arrives, Moran suspects it will show many other pension sponsors failed to lock in gains before equity prices and interest rates fell in the fourth quarter.

“The opportunity to lock in such gains is often fleeting, and unfortunately the volatility in the fourth quarter demonstrated just 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 individual plan's 2018 outcome.

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

Robust voluntary contributions, made as sponsors sought to write them off against the previous corporate tax rate and before rising rates to the Pension Benefit Guaranty Corp. variable premiums set in, masked what would have an even worse fourth quarter for pensions.

GSAM estimates the average funded ratio benefited from a nearly 4 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 gains from the first three quarters of the year won't be fully tallied until full filings are made, GSAM's report notes.

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

Pension plans are “natural buyers” of Treasury Strips for their duration characteristics, writes Moran. “We believe that much of the increase in stripping activity was due to demand from US corporate pension plans.” The value of purchased Treasury Strips increased $60 billion in 2018.

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

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

Expected trends in risk transfer, LDI strategies for the 2019

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

Moran expects sponsors that have already tapped the annuity market will consider returning going forward. Scheduled increases in PBGC's flat rate premium, which is assessed based on the number of participants in a pension plan, will motivate more buyouts, he writes.

Moran expects these trends will emerge as 2019 unfolds:

1. Structuring an LDI portfolio may be more challenging

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

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

“This all suggests a more challenging environment to construct an LDI portfolio and highlights the potential benefits of engaging an active LDI manager with experience in constructing appropriate portfolios. It may also lead some sponsors to contemplate other asset classes outside of corporate credit that may be utilized as part 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 move the liability of retired participants off sponsors' books.

But Moran sees evidence that more sponsors and insurers will be willing to consider more expensive deals, at least in terms of premium, that include existing employees and terminated vested employees. “Transactions that expand out to include more actives and TVs may be the next wave, whether it involves a full plan termination or not,” says Moran.

3. De-risking equity in LDI strategies

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

Recent market volatility is generating interest in defensive and low volatility equity strategies. More sponsors are also considering alternative risk, hedge fund replication, and derivative strategies.

4. Holding more cash

Notwithstanding aggressive voluntary contribution strategies of late, most plans are cash-flow negative, as they pay out more in benefits than they get from cash infusions.

That reality will continue for many plans, as their workforce matures to retirement. That could argue for sponsors to hold more cash to avoid liquidating investments at inopportune times, says Moran. Moreover, cash has the potential to become a strategic asset for pensions as yields rise.

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