Corporate pensions for the largest US companies are in their best shape in over ten years, and this is generally positive news for the employees enrolled in these corporate pensions, according to retirement professionals.
As of September 21, public companies listed in the S&P 500 stock index had an average pension “funded ratio” of 102%, based on data monitored by the financial services company Aon. This marks the highest level since at least the conclusion of 2011 when the ratio stood at approximately 78%.
The funded ratio serves as a means to assess the financial health of corporate pensions. It quantifies a company’s pension assets in relation to its liabilities, essentially comparing the available funds within a pension to the financial obligations a company has for providing future pension income to its employees.
When the funded level reaches 100% or higher, the pension plan has sufficient assets to fulfill its forthcoming financial commitments and obligations.
Byron Beebe, Aon’s global chief commercial officer, expressed optimism about the present funding level, stating that it is a highly positive development and marks its highest in quite some time.
Indeed, as noted by the American Academy of Actuaries, pension funding represents a momentary financial snapshot and can fluctuate due to factors like the overall health of the US economy. It’s important to remember that each pension plan is distinct, and funded status is just one aspect to consider when assessing pension health.
Why is funding significant for corporate pensions?
Over time, corporate pensions have become less common as companies have substituted them with 401(k) style arrangements.
Corporate pension schemes are often called “defined benefit” plans, as they determine workers’ future benefits based on a formula that considers factors like their length of service and earnings.
In 1983, there were approximately 175,000 defined-benefit plans in the private sector, according to US Department of Labor data. However, by 2020, this number had dwindled to around 46,000.
Many of these plans are considered “frozen,” meaning they no longer permit workers to accumulate additional benefits.
Consequently, fewer “active” participants are still in the process of earning pension credits. In 1975, there were 27.2 million active participants, but by 2019, this number had declined by over half to 12.6 million, as reported by the Congressional Research Service.
As stated by the Labor Department, there are approximately 32 million participants in corporate pensions, encompassing both active participants and those who are no longer accruing benefits.
According to Beebe, maintaining a robust pension plan increases the likelihood that companies with active plans will retain them and refrain from terminating or freezing them.
In severe situations, inadequate funding can result in reduced benefits, as experts have pointed out.
Pension failures and PBGC safety net
Companies facing pension failures can transfer their responsibilities to the federal Pension Benefit Guaranty Corporation, which guarantees pension benefits as a financial safety net.
It’s worth noting that beneficiaries don’t necessarily receive their full promised payout through the PBGC. This is because the PBGC insures benefits up to a specific limit, which varies depending on the beneficiary’s age. While most pensioners are unaffected by this limit, those who are affected would experience a reduction in their benefits.
The resurgence in plan funding can be attributed to several key factors. Following the 2008 financial crisis, corporate pension funding faced challenges.
Pension improvement factors
Recent pension plan improvements can be attributed to three key factors:
- Rising interest rates.
- Strong stock market performance.
- Policy changes in how some companies fund corporate pensions.
John Lowell, a partner at October Three, a pension consulting firm, emphasized the key factors.
Higher bond interest rates reduce the immediate need for companies to allocate funds for future corporate pension obligations.
Additionally, insurance premiums paid to the PBGC increase with underfunding, encouraging companies to contribute to reach full funding proactively.
These combined efforts have helped enhance pension funding despite occasional challenges, such as the 2022 stock market decline.
Despite occasional setbacks like the S&P 500’s 2022 decline of over 19%, asset classes like stocks have generally performed well for a decade. This has boosted pension plan assets, as noted by Lowell.
Companies are mitigating market volatility by adopting strategies such as investing in bonds to match future pension obligations, ensuring more stability, as highlighted by Beebe from Aon.