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    GSAM Insights

    SURPLUS SEASON

    Corporate Pension Quarterly 1Q 2023

    April 13, 2023  |  10 Minute Read

    Quarterly Snapshot

     

    Historical Aggregate S&P 500 Funded Status1

     

    Source: Goldman Sachs Asset Management. As of March 31, 2023. Funded status reflects monthly estimates, with the exception of year-end data.

     

     
    • In 1Q, the Moody’s Aa corporate bond yield, a rate often referenced as a proxy for pension discount rates, fell by 23 bps, increasing the value of aggregate pension liabilities by an estimated 2.8%.
     
    • Meanwhile, positive returns across equities and fixed income improved asset performance in 1Q. We estimate that, in aggregate, pension asset returns were 6.0%.
     
    • Year-to-date, asset returns were slightly higher than liability changes, resulting in our estimate of the funded status for the aggregate S&P 500 plan rising from 100% on December 31 to 102% on March 31.

     

     

    Distribution of Funded Status1

     

    Source: Goldman Sachs Asset Management. As of March 31, 2023.
    E = Estimated by Goldman Sachs Asset Management.
    *1 year GS Asset Management projected funded status range using estimates of asset/liability returns and volatility.

     

     

    Portfolio Manager Perspectives

    With funded status having risen drastically over the past few years, many plans have found themselves in an overfunded position, and are now evaluating how to manage their newfound surplus. Bruce Jurin from the Client Advisory Solutions team shares his views on the topic.

     

     

    Bruce Jurin

    Senior Pension Strategist, Client Solutions Group

    Bruce Jurin

    Given the recent rise in funded levels, why is it important for sponsors to shift their investment strategy and asset allocation to something that is more aligned with plan liabilities?

    While we generally believe assets should be invested against liabilities, we believe it is especially important as plans become overfunded. The benefit of being overfunded is less than the cost of being underfunded, due to such factors as PBGC premiums due on deficits and the difficulty of accessing surplus relative to the need to fund in deficit. This doesn’t necessarily mean a sponsor should utilize an all-bond portfolio, especially for active plans that will want to keep up with liability growth including service cost, but it does mean they should be, at a minimum, very liability-aware.

     

    In the pension industry we often refer to “trapped surplus.” What exactly does that mean and how should plan sponsors think about it?

    The term is “trapped surplus” because a sponsor can’t take money out unless all liabilities have been satisfied, either by being paid out or by purchasing annuities from an insurance company (and the plan is formally terminated). Once terminated, any excess reversion to the sponsor is subject to a punitive excise tax. So even if there is a surplus asset on the plan’s balance sheet, the surplus may be “trapped.” If the surplus reverts to the sponsor, a 20% to 50% excise tax is generated along with income tax on any reversion, making it very uneconomical.

     

    Why are the income and excise taxes on surplus so high?

    Remember that the sponsor was entitled to a tax deduction on any contributions, so the income tax assessment brings the sponsor back to par. The excise tax discourages companies from using pensions as a tax-free accumulation vehicle instead of a retirement plan. Under these rules, a company cannot set up a pension plan, get tax-free accumulation, end up in an overfunded position, and then terminate the plan later and take the assets out penalty-free.

     

    There are some tax-friendly allowable uses of surpluses that may be available for sponsors. Could you highlight some of those?

    If sufficiently overfunded, assets from a pension plan can be used to fund retiree health care liabilities, although the rules are complex. If the sponsor purchases a company that has an underfunded plan, the plans can be merged, allowing the surplus to help cure the target’s deficit. If a terminated pension plan is replaced by a defined contribution plan, surplus can fund up to 7 years of contributions in some cases. In addition, sponsors can negotiate with unions (or potentially with non-union employees) to increase pension benefits for other concessions. These are some examples of possible tax friendly uses; whether they apply will depend on the facts and circumstances.2

     

    So, what is the answer for a sponsor? Should they be managing their plan to try and generate surplus to use for these other permissible activities, or should they be trying to limit excess surplus as much as possible?

    As a general matter more surplus is better, but there are considerations around whether sponsors should be taking substantial risk to increase surplus. Some questions that sponsors may want to consider are: Are the pension risks material for your company? Do you offer post-retirement health care benefits? Are you likely to acquire companies that may have underfunded pensions? Is the sponsor in a position to earn concessions in other areas for a higher pension benefit? Sponsors may want to review these and other questions with their advisers as they consider plan surplus.

     

     

    Strategy in Focus: Strategic Uses of Pension Surplus 

    Plan sponsors are evaluating the ways in which pension surplus could be used given the rise in funded levels that has left some corporate DB plans overfunded. Below, we highlight some potential strategic uses of an overfunded pension plan.

     

     

    Source: Goldman Sachs Asset Management. As of March 31, 2023. For illustrative purposes only. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation. 

     
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    Corporate Pension Quarterly 1Q 2023: Surplus Season

     

     

     

     

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    Disclosures:

    1GAAP funded status estimates are based on US plans (where specified) of defined pension plans within the S&P 500 (i.e., 299 companies with pension data per GS Asset Management research). 2. Average asset-weighted return of S&P 500 companies’ US defined benefit plans. 3. Mix of MSCI EAFE and MSCI ACWI ex-US. 4. Mix of Corporates (Bloomberg Agg), High Yield (iShares), Treasuries, and Long Credit (iShares).

    2For illustrative purposes only. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation.

    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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    THESE MATERIALS ARE PROVIDED SOLELY ON THE BASIS THAT THEY WILL NOT CONSTITUTE INVESTMENT ADVICE AND WILL NOT FORM A PRIMARY BASIS FOR ANY PERSON’S OR PLAN’S INVESTMENT DECISIONS, AND GOLDMAN SACHS IS NOT A FIDUCIARY WITH RESPECT TO ANY PERSON OR PLAN BY REASON OF PROVIDING THE MATERIAL OR CONTENT HEREIN. PLAN FIDUCIARIES SHOULD CONSIDER THEIR OWN CIRCUMSTANCES IN ASSESSING ANY POTENTIAL INVESTMENT COURSE OF ACTION.

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    Index Benchmarks

    Indices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices. The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein.

    Standard & Poor’s (S&P) 500 Index is Standard & Poor's Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices.

    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.

    Bloomberg US Corporate Investment Grade Index includes publicly issued US corporate and specified foreign debentures and secured notes.

    US Treasury Bond is a debt obligation backed by the United States government and its interest payments are exempt from state and local taxes. However, interest payments are not exempt from federal taxes.

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    Date of First Use: April 13, 2023.   313739-OTU-1776620.

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