With interest rates rising, companies seek to offload pension liabilities

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Rising interest rates are boosting corporate pension plans, giving CFOs the chance to lighten their companies’ balance sheets and shift liabilities to insurers.

The US central bank has raised interest rates five times this year as it battles persistently high inflation, including last week when it opted for the third straight 0.75 point hike in rates interest rate and indicated further action on rates.

When interest rates rise, the liability of defined benefit plans, a type of pension plan that promises fixed amounts to participants, decreases. Liabilities are based on long-term corporate bond yields and decline as bond yields rise. Yields on long-term corporate bonds rose to 4.7% at the end of August, from 2.76% at the end of 2021 and 2.58% a year ago, according to Mercer LLC, an advisory firm.

Defined benefit plans sponsored by S&P 1500 companies were 101% funded as of Aug. 31, up 6 percentage points from the year-ago period, according to Mercer. Discount rates are expected to continue to climb, further increasing funding levels and making it more attractive for companies to modify their obligations.

In recent years, many companies have closed their defined benefit plans to new entrants and replaced them with defined contribution plans. These plans do not guarantee fixed payments, relieving companies of the pressure to generate certain returns and the costs associated with managing pensions.

Companies must have a fully funded pension plan to fully transfer it to a third party, a process that typically takes one or two years. They can also move only a portion of their retirement obligations, but this still requires a high funded status.

Finance officials and plan sponsors are preparing to unload their plans now because funding levels are high, advisers said. “If interest rates stabilize or decline, funded status could drop quite quickly,” said Matt McDaniel, a partner at Mercer who advises companies on pension risk transfers. This could limit the ability of companies to transfer their plans.

International Business Machinery Corp.

this month it announced that it was removing more than 40% of its defined pension obligations, or about $16 billion, from its books. Tech company shares responsibilities equally among insurers Prudential Financial Inc.

and MetLife Inc.

in a transaction completed on September 13. The plan was 112% funded at the end of last year and will remain more than fully funded after the transaction, the company said. IBM declined to comment further.

Companies transferred $17.1 billion in retirement risk in the first six months of the year, compared with $8.7 billion in the year-ago period, according to Aon PLC, an investment company. insurance that advises on these transfers. Dealing volume typically increases in the second half of the year and volumes this year could exceed those of 2021, when companies transferred $38 billion in pension obligations to insurers, said partner Ari Jacobs. Principal at Aon.

Aon is also benefiting from higher rates, Chief Financial Officer Christa Davies said in a July 29 earnings call. “Every 100 basis point increase in interest rates […] decreases our unfunded pension liabilities, which decreases cash contributions to pension plans,” she said, adding that Aon has taken steps to reduce the risk of its liabilities. This includes freeze and shutdown plans, Ms Davies said. The company declined to comment further.

Pactiv Evergreen Inc.,

a packaging company based in Lake Forest, Ill., announced earlier this month that it was transferring about $660 million, or about 40%, of its U.S. pension liabilities to two subsidiaries of the insurer Athene Holding Ltd. Corp.

, an aluminum producer, agreed in August to transfer about $1 billion in pension bonds to the United States, its fifth such transaction since 2018 for a total transfer of about $3.3 billion in pension obligations. The companies did not respond to requests for comment.

Defined benefit plans typically have investment portfolios that include stocks, commodities, and real estate. Private equity assets can also be part of the mix, although less than for public pensions, which are expected to be affected by the fall in the value of these investments.

Recent stock market declines have hurt some defined-benefit pension plans invested in publicly traded stocks, McDaniel said. Across all asset classes, estimated aggregate assets of S&P 1500 companies were $1.79 trillion at the end of August, up from $2.33 trillion a year ago, according to Mercer.

US stock markets have fallen sharply since the start of the year, with the S&P 500 down around 24% and the Dow Jones Industrial Average down around 20%.

Interest rate hikes add to the consideration of CFOs, alongside funding status and the current state of markets, said Fernando Tennenbaum, chief financial officer of Anheuser-Busch InBev SA. AB InBev, which owns Corona, Bud Light and other alcohol brands, recorded approximately $2.3 billion in net defined benefit pension obligations at the end of 2021. The company is not seeking to adjust its retirement strategy, Mr. Tennenbaum said.

“But if rates go up, that’s another element and you have to reassess,” he said, generally.

The Federal Reserve approved a third straight hike of 0.75 percentage points. Chairman Jerome Powell said he expects interest rate hikes to continue as the Fed battles high inflation. Photo: Kevin Lamarque/Reuters

Write to Jennifer Williams-Alvarez at [email protected]

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