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A CALCULATED (DE)RISK

Corporate Pension Quarterly 3Q 2022

October 18, 2022  |  7 Minute Read


Quarterly Snapshot

 

With inflation continuing to print higher than target, global central bank policy has proven to be more hawkish than expected, contributing to broad sell offs across both equity and fixed income. Despite renewed macro concerns, our estimate of corporate pension funded status rose 1 percentage point in 3Q as negative asset returns were offset by a greater decline in liabilities. We estimate that, in aggregate, pension asset returns were -8.2% and -7.1% for the month and quarter, respectively.

 

 

Historical Aggregate S&P 500 Funded Status1

 

Source: Goldman Sachs Asset Management. As of September 30, 2022. Funded statuses reflect monthly estimates with the exception of year-end data.

 

  • Interest rates moved sharply higher in 3Q as the Fed delivered a 75bp hike and the median Fed interest rate projection for 2022 surpassed 4%. In 3Q, 10y Treasury yields were up 82 basis points (bps) from 2Q levels.

 

  • The Moody’s Aa corporate bond yield, a rate often referenced as a proxy for pension discount rates, increased 70 bps during the quarter. As a result of rising interest rates, we estimate the value of aggregate pension liabilities decreased -8.4% during 3Q.

 

  • Quarter-over-quarter, asset returns were less negative than liability changes, resulting in our estimate of the funded status for the aggregate S&P 500 plan rising from 95% on June 30th to 96% on September 30th.

 

Distribution of Funded Status

 

Source: Goldman Sachs Asset Management. As of September 30, 2022. E = Estimated by Goldman Sachs Asset Management.

 

 

Portfolio Manager Perspectives

 

The first half of 2022 saw $17.6bn in single premium buy-out and buy-in sales, surpassing the prior record of $9.7bn in 1H 2018. IBM’s $16bn mega transaction in 3Q comes amid growing plan sponsor interest in pension de-risking strategies. Lindsay Howard in the GS Asset Management Multi Asset Solutions Group shares her views on the topic.

 


Lindsay Howard, FSA, CFA

Multi Asset Solutions Group

Lindsay Howard, FSA, CFA


Strategy in Focus: Pension Risk Transfer

 

With some corporate DB plans at or close to fully funded, many plan sponsors are evaluating whether it may make sense to transfer some or all of the pension risk on their balance sheets to an insurer. Pro-forma for an annuitization transaction, the insurer would be responsible for making benefit payments and the plan sponsor would no longer be required to make contributions to satisfy potential deficits. Below, we outline certain considerations should a company be interested in exploring an annuitization transaction. To determine whether a risk transfer might make sense, a plan sponsor may want to consider transaction size, costs, financial impact, timeline, and other factors as detailed below.

 

What are some of the drivers of the record growth in pension risk transfer activity seen this year?

Pension plan sponsors are continuing to face rising PBGC premiums, which increase the cost of maintaining their plans. Meanwhile, many of them have recently found themselves in a strong funding position despite turbulence in markets, which makes a pension risk transfer (PRT) more affordable. Funding positions have improved largely due to rising interest rates over the past two years, which have significantly reduced the present value of pension liabilities. Many plans are now fully funded or even overfunded, resulting in a higher likelihood that a risk transfer can be completed without requiring incremental contributions from the plan sponsor. These factors have encouraged plan sponsors to enter into risk transfer agreements as they look to avoid future investment and interest rate risks, demographic risks, and mounting costs while they are “still ahead”. Given the increasingly competitive insurer PRT marketplace, a risk transfer can be an attractive way to save on annual costs and potentially reduce the overall expected cost for plans.

 

What types of plans may be suitable for a pension risk transfer?

While there is no “one size fits all answer,” there are certain factors that may make a plan a more likely candidate for risk transfer. This includes plans that are better funded and therefore may be able to execute a transaction without incremental contributions or plans that have a large number of participants with relatively small monthly benefits. Oftentimes, though, the strongest motivating factor for risk transfer may be a desire to “right size” the pension in relation to the size of the sponsor. A plan that is significantly large may contribute to unwanted financial risks, such as balance sheet, income statement and contribution volatility. Reducing or terminating the plan can alleviate those risks.

 

How should plan sponsors interested in participating in a risk transfer think about positioning their portfolios?

Many sponsors will pay for a risk transfer through an “in kind” delivery of securities. In these cases, insurers tend to be partial to off-the-run high quality fixed income securities, often those that a plan has already accumulated as part of its liability driven investment program. For a sponsor that wishes to ultimately terminate its plan, it may also wish to consider reducing or ending new commitments to private market securities with a long tail. Liquidating those positions or delivering them “in kind” to an insurer to pay for a group annuity contract may result in an unpalatable markdown.

 

How can engaging with an asset manager be helpful in the risk transfer process?

An asset manager partner can help quantitatively evaluate the impact of a potential transaction, including comparing transaction costs and savings vs. the cost of maintaining the plan. The manager can also help build an “insurer-ready” bond portfolio to help reduce transaction costs while immediately hedging liabilities. For partial risk transfers, the manager can help determine an appropriate mix of growth vs. immunizing assets for the remaining portfolio. We have found that PRTs generating short-term cost savings may increase the long-term expected cost of the plan when not paired with an appropriate change to the remaining plan’s investment strategy. Many plan sponsors choose to partner with an Outsourced Chief Investment Officer to help realize the risk reduction and cost savings they seek via PRT.

 

 

Source: Goldman Sachs Asset Management. As of September 30, 2022. For discussion purposes only. De-risking strategies should not be construed as providing any assurance or guarantee that as a result of applying the strategy an investor will reduce and/or eliminate risk, as there are many factors that may impact end results such as interest rates, credit risk and other market risks. This does not constitute a recommendation to adopt any particular de-risking strategy. There is no guarantee that any potential benefits or considerations will be achieved.

 

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Corporate Pension Quarterly 3Q 2022: A Calculated (De)Risk

 

 

 

 

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Disclosures

RISK CONSIDERATIONS

Equity securities are more volatile than bonds and subject to greater risks. Small and mid-sized company stocks involve greater risks than those customarily associated with larger companies.

Bonds are subject to interest rate, price and credit risks. Prices tend to be inversely affected by changes in interest rates.

High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities.

Investments in foreign securities entail special risks such as currency, political, economic, and market risks. These risks are heightened in emerging markets.

An investment in real estate securities is subject to greater price volatility and the special risks associated with direct ownership of real estate.

Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.

Alternative investments often are speculative, typically have higher fees than traditional investments, often include a high degree of risk and are suitable only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase volatility and risk of loss.

Alternative Investments by their nature, involve a substantial degree of risk, including the risk of total loss of an investor's capital. Fund performance can be volatile. There may be conflicts of interest between the Alternative Investment Fund and other service providers, including the investment manager and sponsor of the Alternative Investment. Similarly, interests in an Alternative Investment are highly illiquid and generally are not transferable without the consent of the sponsor, and applicable securities and tax laws will limit transfers.

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Index Benchmarks

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Bloomberg US Aggregate Bond Index represents an unmanaged diversified portfolio of fixed income securities, including US Treasuries, investment grade corporate bonds, and mortgage backed and asset-backed securities.

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