As we have turned the page on 2017 and look forward into the rest of 2018, the US corporate defined benefit (DB) system seems to be at an inflection point on multiple levels.
Below, we provide some thoughts and observations around how corporate DB plans ended 2017 and some strategies these plans may employ in 2018.
Robust contribution activity combined with double-digit asset returns for many plans will likely result in the first annual rise in funded status for the US corporate DB system since 2013.1 Our model suggests the aggregate funded status of the US corporate DB universe was 85% as of the end of 2017, up from 81% at the beginning of that year. Key factors that influenced changes in funded status in 2017 include:
As noted earlier, one of the main catalysts for the likely increase in funded levels in 2017 was notable voluntary contribution activity. Companies such as Boeing, Verizon, Delta, and FedEx all made multi-billion discretionary contributions in their most recently completed fiscal years. In the past, many sponsors employed a fairly straightforward contribution strategy. That is, they contributed the minimum required under ERISA given other potential uses of cash for actions such as buybacks, dividend increases, capital expenditures, and mergers and acquisitions. Now, given higher PBGC premiums on deficits and a limited window of opportunity to contribute and potentially reap a tax deduction at the old, higher corporate tax rate, more sponsors are accelerating voluntary contributions.
When plans report their year-end asset allocations along with their other pension-related metrics over the next few weeks, some plans may once again report an increase in their overall fixed income allocations. These allocations have been slowly rising over the past few years despite persistently low interest rates and funded levels. With many plans having some sort of glide path or journey plan in place that calls for increased allocations to fixed income as funded status improves, increases in funded levels, whether due to asset returns or contributions, would be expected to be a catalyst for increased rotation into long-duration fixed income. Some of these increases to fixed income allocations may be sourced from equities or other asset classes with more return seeking characteristics. As we expect notable contribution activity to continue in 2018, additional increases to fixed income allocations may occur again this year.
Our outlook for 2018 is more of what we observed in 2017, except in many ways accelerated. We expect many plan sponsors may continue to voluntarily contribute to their plans, shift asset allocation to one that better aligns assets with liabilities and reduces exposure to equity beta, and shrink their plans through risk transfer actions. Several catalysts may drive these actions: