Corporate Funds, Institutional Investors, Pension Funds, Performance Measurement

New Tax Law & Increased Discount Rate Impact Year- End Corporate DB Funding Status

The estimated aggregate funding level of the 1,500 defined benefit pension plans listed on the S&P Composite 1,500 Index, year-end 2018, increased to 85 percent from 84 percent, at the end of 2017, according to data compiled by Mercer. The reason for the rise in funding levels may be two-fold. Deep drops in the equity and fixed income markets were offset by increases in the discount rate, according to Mercer. “Rising discount rates decreased pension liabilities during the year. This slightly outweighed the losses in equity markets,” said Matt McDaniel , partner, leader of Mercer’s US Financial Strategy Group.

Matt McDaniel, partner, leader of Mercer’s US Financial Strategy Group

Also during 2018, many plan sponsors accelerated contributions to take advantage of tax reform {Tax Cuts and Jobs Act of 2017],” said Scott Jarboe, partner in Mercer’s Wealth business, in a press release.

Jay Kloepfer, head of capital markets research at Callan observed similar activity. “On the funding side, we had a number of our corporate plans put money in last year, because of the tax benefit of doing it by September.  Plans put in a substantial amount of money by September and that really improved their funded status, so year over year their funded status is way up,” he said. “Not for all of them, but for many their status improved,” he added.

Dan Kutliroff, head of OCIO business strategy at Northern Trust Asset Management expects similar results.When the data comes out, with respect to corporate pension funds, we expect to see the large cash allocations from the funding side that corporations made to their pension plans in 2018 to take advantage of the tax reform changes. With the old rates, the plans got a 35% deduction, when making a contribution to the pension fund. The new tax rate deduction is only 21% and because of the regulatory period most funds had until Sept 15 of 2018 to do so,” he said.

The estimated aggregate deficit of corporate DB plans hit $312 billion as of Dec. 31, 2018, which is $63 billion less than the $375 billion deficit at the end of 2017, according to Mercer’s data. In fact, throughout most of 2018, corporate funded status for DB plans remained higher than in 2017. By November 2018, funded status had reached 91%, however, when the stock market tumbled in December that figure dropped to 85 percent, as a result of both a decrease in US equity markets and a decrease in discount rates in December. “A decrease in discount rates causes pension liabilities to rise and funded status to fall, holding all other factors constant. In December, rates fell by 20-25 basis points, while equity market returns were negative. Both factors decreased funded status,” McDaniel said.

Interest rates for long duration, high-quality corporate bonds over the course of 2018 increased about 60 basis points, while equity markets experienced huge losses. The S&P 500 total return index lost 4.38 percent during 2018 and the MSCI EAFE total return index lost 13.36 percent. Typical discount rates for pension plans, as measured by the Mercer Yield Curve, increased by 63 basis points during 2018 to 4.19 percent.

Mercer estimates the aggregate funded status position of plans sponsored by S&P 1500 companies on a monthly basis. Figure 1 (below) shows the estimated aggregate surplus/(deficit) position and the funded status of all plans sponsored by companies in the S&P 1500. The estimates are based on each company’s latest available year-end.

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