Taking Stock: Increasing Pension Contributions and Improving Corporate Pension Funding Ratios: Now What?

Funded status for a typical pension plan has improved amid higher contributions fueled by tax reform and a flattening yield curve. Even though the S&P 500 has returned 2.6% year to date as of June 30, pension plan liabilities have declined by approximately 7.8% since the beginning of the year, according to the Citigroup Pension Liability Index, amid rising interest rates.

We expect this trend in increased funding to continue as pension contributions are one of a few deductions that can be claimed relative to the prior year. Contributions made before September 15 and filed with tax returns can be deducted for 2017. In addition, the increase in pension contributions also lowers annual PBGC premiums as it reduces a plan’s unfunded liability. PBGC premiums have been increasing in recent years through legislation and are now essentially a 4% tax on unfunded plan liabilities.

As companies make their plan contributions ahead of the September deadline, a potential area of concern is the capacity constraints of long-duration corporate bonds and transaction costs associated with acquiring these bonds. It is possible that as capital finds its way into the hands of portfolio managers, the pricing of long-credit bonds could become increasingly unattractive. Therefore, we suggest that plan sponsors work closely with NEPC and their managers to minimize transaction costs.

We recommend clients examine concentration risk related to issuers across their plan’s fixed-income managers. We generally support diversifying among fixed-income managers if terminating the plan is not a short-term goal.

For clients with a de-risking glidepath in place, we estimate how incoming contributions affect plans’ funded status and where plans move down their glidepaths. In the case of very large contributions, multiple glidepath triggers may be hit at one time. We continue to support a dynamic de-risking strategy as funded status improves.

At NEPC, we look forward to working with your investment managers and you to find the most efficient and cost-effective way to deploy additional plan contributions while keeping your interest-rate hedging strategy on target. For more details, please contact your NEPC consultant, and stay tuned for more on this topic in an upcoming survey.