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Aon Retirement and Investment Blog

U.S. Corporate Pensions Year in Review: 2017 Recap and 2018 Opportunities

Many U.S. private sector pension plan sponsors saw funded ratios increase over 2017, supported by strong equity market performance. Underfunded plans continue to present opportunities for risk management through investments and other strategies.
2017 Year in Review
U.S. private sector pension funded statuses improved in 2017 according to Aon’s Pension Risk Tracker, following suit with overall trends of growth and stability in global markets relative to 2016. Aon’s S&P 500 funded ratio benchmark increased by 1% from 81% to nearly 82%[1] (Exhibit 1)
Exhibit 1: PBO Funded Ratio of S&P 500 Pension Plans During 2017

Actual pension performance varied by sponsor, but many were subject to a few key themes:
  1. Strong equity market performance- Both U.S. (S&P 500) and global equities (MSCI ACWI IMI) finished the year up by 21.82% and 23.95%, respectively[1]; equities generally outperformed fixed income.
  2. Long bond yields decreased, pension liabilities increased- The BBG Barclays Long Corp AA Index proxy for long duration pension liabilities returned 11.06%.
  3. Plans with larger equity allocations and longer duration bonds may have fared better- Equities generally outperformed fixed income, and long duration bonds outperformed aggregate (market duration) bonds (Exhibit 2).

Funding relief legislation generally offered continued reprieve from mandatory cash funding requirements, but some sponsors saw additional funded status improvement due to discretionary cash funding (e.g., to reduce variable rate PBGC premiums).
As a result of positive 2017 pension performance, many plan sponsors de-risked investments by increasing allocations to liability-hedging fixed income and decreasing return-seeking assets like equities. Others may be approaching a future de-risking trigger.
Opportunities to Refine Pension Risk Management Strategies in 2018
Sponsors greeting 2018 with either positive or negative outlooks may find that it is a good time to determine how much investment risk they want to take and where. To this end, portfolio risk decomposition can help sponsors identify key risks in their pension investments, determine which risks they want to take and which risks they do not want, and align their risk budget with their views (or their advisor’s).
The use of diversifiers[1] can reduce exposure to equity markets and reduce overall surplus risk to better lock-in funded ratio gains (Exhibit 3). Specific diversification strategies we find attractive at the beginning of 2018 include:
  • Insurance-linked securities
  • Private debt
  • Factor-based strategies in equities
  • Non-directional low correlation alternative strategies, for example global macro and some CTA strategies
  • Investments capturing an illiquidity premium
Exhibit 3: Surplus Risk Impact of Diversifiers

The use of custom liability-hedging portfolios can reduce exposure to fixed income markets and reduce overall surplus risk to better lock-in funded ratio gains (Exhibit 4). Specific custom liability-hedging strategies we find attractive include:
  • Long duration credit, or investments that capture credit spreads
  • Long government bonds/Treasury STRIPS, particularly for diversification and duration extension at higher return-seeking allocations, managed with a phase-in strategy based on interest rate views (Hedge Path) and credit spread views (Credit Path)
  • Derivatives for additional flexibility and refinement of interest rate exposure
 Exhibit 4: Surplus Risk Impact of Custom Liability-Hedging

These investment risk management tools can be implemented dynamically/opportunistically as risk preferences change over time or based on market conditions.
In addition to investment risk management strategies, other non-investment strategies continue to have appeal in 2018, particularly to reduce the impact of increasing PBGC premium rates. Discretionary cash funding may be particularly attractive in 2018 to the extent these increase the tax deduction on pension contributions prior to lower corporate tax rates taking effect[1]. Also, while newly adopted IRS mortality tables will generally result in higher funding requirements, PBGC premiums, and minimum lump sum payments, sponsors can elect to use custom mortality tables and pursue opportunistic settlements to mitigate some of these impacts.

After generally positive news for U.S. corporate pensions in 2017, sponsors may want to revisit investment risk exposures to improve alignment with their capital market outlooks. In particular, opportunities may be present to refine equity and fixed income market exposures through the use of diversifiers and custom liability-hedging portfolio strategies. In addition, non-investment strategies including discretionary funding and custom mortality tables can be used to reduce the burden of increasing PBGC premiums.
Richard Parker FSA, EA is a senior investment consultant in the Investment Policy Services group, based in Denver, CO
Phil Kivarkis, FSA, CFA is the US Director of Investment Policy Services, based in Lincolnshire, IL
Click here for benchmark descriptions.

[1] Aon Hewitt is not a tax adviser. Plan sponsors should consult with tax counsel to determine tax strategy.

[1] Diversification cannot ensure a profit or protect against loss in a declining market. It is a strategy used to help mitigate risk.

[1] Benchmark returns as of 12/29/17

[1] Aon S&P 500 Pension Risk Tracker reflects data disclosed in FYE 2016 financial statements and interim funding updates based on roll forward applying market proxies

Content prepared for U.S. subscribers, but available to interested subscribers of other regions.

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