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The Tide is High

January 6, 2023  |  9 Minute Read


History will reflect that 2022 was a wild ride on many levels. US equities entered a bear market and many other equity markets around the world suffered even larger drawdowns. Interest rates rose notably, credit spreads widened, the US Treasury yield curve had its largest inversion in over 40 years, and fixed income investors saw some of their largest annual losses ever. Conversations around whether the US will enter recession, and, if so, when and how deep it would be, were pervasive.


Despite all of this, US corporate defined benefit (DB) pension plans are in their best shape in 15 years. According to our analysis, aggregate system-wide funded status has risen to 100%, the first time it has ended a calendar year in a fully or overfunded position since before the 2008 global financial crisis. While plan assets have declined significantly due to the fall in both equity and fixed income values, liabilities have fallen even further. Per our estimates, rising interest rates and widening credit spreads will likely allow plans to use accounting discount rates in excess of 5% at the end of 2022, the highest in over 10 years.


Notwithstanding this position of strength, this is a crucial time for many plans and their sponsors. Some plans have previously found themselves in overfunded positions in the past only to see surpluses dissipate based on financial market movements, in particular with falling interest rates. Concerns around a potential recession are still quite high, and the possibility of such a scenario is not insignificant. Indeed, in just six weeks after hitting a year-to-date high of about 4.4%, yields on 30-year US Treasury bonds declined around 100 basis points (bps) before rising again towards the end of the fourth quarter.


While the rise in funded levels is welcome news, some plans may face higher pension expense next year given the mechanics of the calculations. And differences in accounting and Employee Retirement Income Security Act (ERISA) funded status calculations could mean some plans may have higher contribution requirements despite the increase in generally accepted accounting principles (GAAP) funded percentages.


As we recap the last 12 months, we also want to provide a look at the themes that we believe will be relevant for plan sponsors in 2023.


Exhibit 1: System-wide Funded Status Hit 100% for the First Time in Over a Decade

Source: Goldman Sachs Asset Management and company reports. As of December 2022. Based upon all the US (when specified) defined benefit plans of S&P 500 companies. For illustrative purposes only. The 2022 (E) figure is estimated and unaudited as of December 31, 2022 and is subject to potentially significant revisions over time. All illustrations of funded status, surplus and related funding information in this material are based on actuarial data provided by your actuary where appropriate. Illustrations reflect one possible outcome and reflect a number of assumptions which are disclosed therein. Goldman Sachs is not providing actuarial services in connection with providing the information contained therein.


Glancing Back: Corporate DB Plans Benefited From Historically High Inflation


Funding Levels Build on 2021 Gains to Likely Finish Higher Once Again


While the highest inflation in decades certainly caused consternation for many investors in 2022, corporate DB pension plans benefited from falling liability values due to higher interest rates. As seen in Exhibit 2, actuarial gains—reflecting the lowering of pension obligations due to the use of higher discount rates—helped to drive funded status higher in 2022. These gains offset the declines in asset values from falling asset values across equity, fixed income, and alternative asset classes. Plans that were less well-hedged benefited more in 2022, but better hedged plans have experienced less funded status volatility over the past several years and, in our opinion, are in a stronger position today to preserve recent improvements.


Exhibit 2: The Story in 2022 Was a Sharp Decline in Pension Obligations, Primarily Due to Higher Interest Rates

Source: Goldman Sachs Asset Management and company reports. As of December 2022. Based upon all the US (when specified) defined benefit plans of S&P 500 companies. For illustrative purposes only. The 2022 (E) figure is estimated and unaudited as of December 31, 2022 and is subject to potentially significant revisions over time. Actual returns may vary significantly from the performance information presented above. The chart shows the percentage impact of factor on the change in funded status between starting and ending periods. Exhibit may not sum due to rounding. All illustrations of funded status, surplus and related funding information in this material are based on actuarial data provided by your actuary where appropriate. Illustrations reflect one possible outcome and reflect a number of assumptions which are disclosed therein. Goldman Sachs is not providing actuarial services in connection with providing the information contained therein. Past performance does not guarantee future results, which may vary.


Calendar Year Companies Will Likely Be Using Their Highest Discount Rates in Over 10 Years


Fixed income investors experienced tumult in 2022, with 30-year US Treasury yields rising about 250 bps at one point during 2022 and credit spreads widening. While corporate DB plans saw their fixed income holdings fall notably given this dynamic, their liabilities declined as well (see Exhibit 2).


The biggest headwind for pension plan funded status over the past two decades has been steadily declining interest rates. Since pension obligations are valued for GAAP accounting purposes based on the yields of high-quality corporate bonds on the last day of a company’s fiscal year, falling interest rates contributed to a notable increase in gross pension obligations.


Consequently, while historically high inflation was a source of much angst for all investors in 2022, higher interest rates may allow corporate DB plans to use higher discount rates to value their pension obligations at the end of 2022. The Moody’s Aa corporate bond yield, a popular proxy for pension accounting discount rates, had risen over 225 basis points (bps) in 2022 through the end of December. We expect this should allow for plans to apply the highest discount rates in almost a decade. This is real economics—not just accounting—as higher interest rates make it more cost effective for a plan to immunize its pension obligations through a liability driven investment program or engage in a pension risk transfer through the purchase of a group annuity.


Exhibit 3: Rising Discount Rates Provided Relief for Corporate DB Plans

Source: Goldman Sachs Asset Management and company reports. As of December 2022. Based upon all the US (when specified) defined benefit plans of S&P 500 companies. For illustrative purposes only. The 2022 (E) figure is estimated and unaudited as of December 31, 2022 and is subject to potentially significant revisions over time. Based upon the arithmetic average of US plan discount rates (when specified) of S&P 500 companies. Analysis for each year only includes those companies with a December fiscal year-end.


A Record Year for Pension Risk Transfer, With Potentially More to Come in 2023


Through the first three quarters of 2022, group annuity sales exceeded $40 billion, a record year with a full quarter still to go (see Exhibit 4). As the fourth quarter has historically been strong for group annuity sales, we believe the final total for 2022 should move significantly higher and will likely exceed $50 billion.


Exhibit 4: Record Pension Risk Transfer Activity Which May Continue in 2023

Source: LIMRA US Group Annuity Transfer Study and Goldman Sachs Asset Management. As of Q3 2022 (latest available). 2022 data is year-to-date through September 30, 2022.


Higher interest rates, and therefore higher funded levels, have made it easier for sponsors to effectuate a pension risk transfer as, in many cases, an incremental contribution may not be needed to complete the transaction. In addition, for plans that are frozen and overfunded, the ability to use surplus for anything other than pension or other retiree-related benefits may be limited, providing further incentive to either fully immunize the plan or execute a risk transfer.


With funded levels remaining high, we expect 2023 to be another robust year for pension risk transfer activity. As Pension Benefit Guaranty Corporation (PBGC) premiums continue to rise, raising the cost for sponsors to maintain their plans, this provides further incentive for actions to shrink or, in some cases, terminate plans. For example, PBGC flat-rate premiums have increased to $96 per participant in 2023, which is a 9% increase over the 2022 level.


Nonetheless, we note the increased interest in Washington, D.C. around pension risk transfer activity, in particular, private equity-backed insurers engaging in these transactions. For example, at the September 8, 2022 US Senate Banking Committee hearing, Senator Sherrod Brown (D-OH) and Senator Elizabeth Warren (D-MA), expressed concern around the riskier investment strategies of PE-controlled insurers and the impact on participants from pension risk transfer. However, at the same hearing, outgoing Senator Patrick J. Toomey (R-PA) came to the industry's defense, stating that pensioners are well-protected by state insurance regulators after pension risk transfer transactions, noting that that private-equity owned insurers are subject to rigorous state regulations similar to other insurers.


In addition, “SECURE Act 2.0,” included as part of the recently passed omnibus bill, requires the Department of Labor (DOL) to review the interpretative bulletin governing pension risk transfers and determine if any amendments are needed. The DOL must report its findings to Congress within one year, including an assessment of any risks to participants. For sponsors potentially looking to explore these transactions in 2023 or beyond, we believe this is a development worth monitoring.


Looking Forward: Operating From A Position of Strength


Plotting an End-state Portfolio and Evaluating the Use of Surplus Options


With funded status having risen so much over the past two years, many plans are at a crucial point where they are at or near a fully funded level. Yet their asset allocation still maintains significant mismatch between plan assets and liabilities, thereby exposing the plan and the sponsor to a substantial amount of risk. We believe one of the greatest dangers these plans face is lower interest rates.


We have seen this play out before. As depicted in Exhibit 1, the system was overfunded (as was the case with many individual plans) in 2007, but unfortunately saw that surplus disappear during the 2008 global financial crisis. A similar dynamic occurred after the equity bull market of the 1990s. Soaring equity values had boosted funded ratios, but the tech bubble burst of 2000, followed by the tragic events of September 11th, contributed to an expansion of funding deficits. These deficits, at times, played a role in rating agency downgrades, negative implications for sponsor equity valuations and, in some cases, bankruptcy.


In addition, as has always been the case with corporate DB plans, the risk with funded status is asymmetrical. Sponsors bear the responsibility for funding deficits, including paying PBGC variable-rate premiums, but do not enjoy the benefits of surpluses, as depicted in Exhibit 5.


Exhibit 5: Shrinking the Cone of Outcomes Becomes More Critical As Funded Status Rises

Source: Goldman Sachs Asset Management. For illustrative purposes only.


While there are certain allowable uses of surplus—such as paying for ongoing service costs, using the surplus for underfunded plans acquired in an acquisition, or transferring to a retiree healthcare plan to fund those liabilities—those options are limited and subject to restrictions. Sponsors have an incentive to shrink the potential distribution of outcomes since at a certain point taking too much risk could result in a notable drawdown in funded status or alternatively, surplus that is not able to be utilized in an economic manner.


After Two Decades of Declines, EROA Assumptions Are Poised to Rise in 2023


Corporate DB expected return on asset (EROA) assumptions have been on a steady decline since the early 2000s. A combination of glide path strategies, which have led to increased allocations to fixed income at the expense of equities, and a historically low interest rate environment, contributed to the average EROA for corporate plans declining from about 9% in 2002 to less than 6% in 2022.


That decline may soon turn around. The rise in US Treasury yields in 2022 and the sell-off in risk assets has led to a reset on long-term return assumptions for many individual asset classes. Indeed, our strategic long-term return assumptions have been upwardly adjusted in recent periods. Consequently, not only may EROA assumptions stop falling, but in some cases, they may be upwardly adjusted for 2023.1


Over the past few weeks, several off-calendar year-end companies have filed their 10-K annual reports with the Securities and Exchange Commission. In some cases, they have provided guidance on the 2023 EROA assumption to be used for pension accounting purposes, thereby supplying us with real time information on how some sponsors are thinking about adjusting their assumptions for 2023. We have noticed two approaches from these companies. In some cases, the plan has left the EROA unchanged for 2023 in relation to the assumption used in 2022. However, we have also observed plans increase this assumption by 100 basis points or more for 2023 financial reporting purposes. We believe that a number of plans may be increasing their EROA assumption for 2023, and the long-term decline in this metric may actually reverse.


Exhibit 6: Many Plans May Raise Their EROA Assumption in 2023

Source: Goldman Sachs Asset Management and company reports. As of December 2022. Based upon all the US (when specified) defined benefit plans of S&P 500 companies. For illustrative purposes only. The 2022 (E) and 2023 (E) figures are estimated and unaudited as of December 31, 2022 and is subject to potentially significant revisions over time. These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary.


Not All that Glitters Is Gold — Headwinds May Develop for Earnings and Contributions


While some US corporate DB plans are enjoying their highest funded levels in years, there are potential pitfalls that sponsors should bear in mind. For some plans, despite any increase to funded levels, pension expense may increase in 2023. The decline in asset values means expected return income may be lower in 2023, even if the EROA assumption is increased as discussed above.


While higher discount rates lower the value of liabilities, that rate then drives the interest cost component of pension expense. And although lower liability values may result in large recognition of actuarial gains at the end of 2022, we believe actual plan asset losses will in many cases offset these, in particular when taking into account that plans assume a positive asset return in their accounting throughout the year. In short, as with many things associated with GAAP pension accounting, the financial reporting for these plans can get complicated quite quickly.


Similarly, while liabilities will fall for GAAP accounting purposes given higher interest rates, for ERISA funding purposes they may not change at all given the mechanics of the many smoothing elements to the calculations. Consequently, some plans may see contribution requirements rise more than they expected over the next several years even though GAAP funded ratios have moved up substantially.





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1. For additional information, please see Goldman Sachs Asset Management’s report from September 2022 titled “Defined Benefit EROA Assumptions 2022: Finding a Bottom?”


Basis point (bp) refers to one hundredth of one percent.

Bear market refers to a prolonged period over which the value of a market index declines 20% or more from its most recent peak.

Drawdown refers to the decline in an asset’s value relative to its most recent peak.

Expected Return on Assets (EROA) assumption refers to the expected long-term annual return on plan assets. The assumption is influenced by plan asset allocation, future expected asset class returns, and potentially, historical returns.

Generally Accepted Accounting Principles (GAAP) refers to accounting rules and standards for financial reporting, and is the standard adopted by the U.S. Securities and Exchange Commission (SEC).

GAAP Discount Rate refers to the discount rate used to value pension liabilities per GAAP accounting rules and standards. It is based upon yields available on high quality corporate bonds at the end of a company’s fiscal year (i.e., not a smoothed or averaged rate).

Pension Buy-Out refers to a transaction whereby a pension plan sponsor transfers some or all of its pension obligations to an insurer.

Percentage point (pp) refers to the arithmetic difference between two percentages.

Risk assets refers to investments that may be subject to meaningful price volatility, such as equities, commodities, real estate, etc.

Risk Disclosures

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.

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.

General Disclosures


Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

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Alpha and tracking error assumptions reflect Multi-Asset Solutions’ estimates for above-average active managers and are based on a historical study of the net-of-fee results of active management. Expected returns are estimates of hypothetical average returns of economic asset classes derived from statistical models. There can be no assurance that these returns can be achieved. Actual returns are likely to vary. Please see additional disclosures.

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Index Benchmarks

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Moody’s Aa Corporate Bond Index refers to an index of corporate bonds given an Aa rating by Moody’s investor service, and is a popular proxy for pension accounting discount rates.

S&P 500 Index is the Standard & Poor's 500 Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes. It is not possible to invest directly in an unmanaged index.

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Date of first use: January 6, 2023. 302663-OTU-1722966.