For the lucky few, corporate pension plans have left some employees feeling secure about their retirement, a rare experience after the economic wreckage of the pandemic.
Corporate pension plans saw significant improvement in 2021, driving their aggregate funded status — or the financial ability of the pension plan to cover intended expenses and costs in the future — to its best level since before the 2008 financial crisis, according to an analysis by Willis Towers Watson.
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Of the 361 Fortune 1,000 companies WTW analyzed, the aggregate pension funded status jumped to 96%, an eight-percentage-point increase from 2020. This means less pressure on the companies sponsoring those plans to add cash contributions, and allows them to continue to support employees toward a financially secure retirement.
“The improved funded status does provide additional opportunities for plan sponsors to move their pension strategy forward in 2022,” says Jennifer Lewis, senior director of retirement at Willis Towers Watson. “We expect that the pension risk transfers [which shift the plan liabilities either to an insurance company or plan participant] will continue at a significant pace. We also think that some companies will really try to reevaluate their long term intentions for these plans and try to make sure that their long term objectives are aligned with their business needs.”
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Lewis recently spoke with Employee Benefit News about why pension plans saw such a significant rebound and what employers should consider about their pension plan strategies for 2022.
How do corporate pension plans differ from a 401(k)?
The pension plan benefits don't change based on the funded status of the plan. In a defined benefit plan, the benefits are promised and then the company is responsible for providing the funds to pay those benefits. So it’s different from your 401(k) plan, where as the assets rise and fall, the participants' benefit goes up and down. We would expect that the positive equity returns have also helped many 401(k) plan balances during 2021. But the positive performance in these corporate pension plans doesn't affect the level of benefits for participants.
Which provides employees with more financial stability in retirement?
Typically, a defined benefit pension plan — like the ones we're talking about here — provides more stability to an employee than the 401(k) plan. That’s because this benefit is defined as a monthly amount, and often is paid as a monthly amount. In the 401(k) plan, the participants’ benefit is subject to all of the fluctuations in market returns. We've seen the positive side of this in 2021, but in some years we’ve seen the negative as well.
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In addition, the 401(k) participant is responsible for how that money gets drawn down in retirement. So if they go and buy a boat when they retire, they could have used a significant amount of their retirement savings to do so and not have as much left to live on for all of the years of retirement. So it's more incumbent on the retiree to make good decisions about their money for the long term.
However, defined benefit pension plans have been decreasing in prevalence for many years now. We see probably less than 25% of companies offering a pension benefit to a new hire. There still are a lot of companies who have a closed or frozen plan — meaning they used to provide that benefit to employees. So they still have the obligation to pay benefits that were promised a long time ago. But now the prevalent retirement benefit is defined contribution like the 401(k).
But these funds did see financial gains in 2021 – what drove that?
We saw two main drivers of the improved funded status in 2021. The first was equity returns, which significantly improved the fund level. The second factor was interest rates rising during the year. As interest rates rise, liabilities decrease, and so as a result, we were seeing the asset level go up and the liability levels go down, which improves funded status.
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Before the 2008 financial crisis, in aggregate, the plans were over 100% funded — so we would consider them fully-funded. Since the financial crisis, they've been hovering in the 70% to 90% funded range. And this year, we saw that funded status reached 96%, a significant improvement over what we've seen over the past 15 years.
Given this improvement, what might employers' pension strategies for 2022 look like?
For plans that are still open and earning new benefits for employees, we think this could be the boost they need. We think that the improved funded status is going to encourage employers to continue to provide that benefit. In the extremely competitive market for talent that we're seeing right now, such a benefit could be an important differentiator.
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We do think that the higher funded status leaves a lot of opportunities for plan sponsors for 2022 and beyond. It opens up continued opportunities to do pension risk transfers, as well as considering hibernation or reducing some of the risks that they have in the plans. Pension risk transfers shift the liabilities, either to an insurance company or shifting the benefits to the participant, so that the plan sponsor is no longer responsible for them in the future.
What we saw a lot of in 2021 was the purchasing annuities from insurance companies. So in that case, the retiree continues to get the same benefit, but now that benefit is paid by an insurance company instead of the plan. So the company no longer has an obligation for that benefit in the future.
