The latest release of the Milliman Pension Funding Index, which tracks performance at the largest U.S. private pension plans, shows February brought moderate funded status improvements despite falling discount rates.
The index is published monthly by Milliman and tracks the
100 largest defined benefit (DB) pension plans sponsored by U.S. employers
(i.e., the Milliman 100). In February, these plans experienced a $32 billion
increase in asset values, but also saw a $21 billion increase in pension
liabilities resulting from falling interest rates—driving an $11 billion
overall improvement in pension funded status.
“In February, these plans were buoyed by strong market
performance that offset yet another increase in pension liabilities,”
explains John Ehrhardt, co-author of the Milliman Pension Funding Index.
“For the year, we’ve seen liabilities increase by more than $80 billion in
response to rate movements. These rates have defined pension performance for
the last several years. We’ll need some cooperative rates to get back to full
funding.”
Put simply, falling rates increase long-term pension plan
liabilities because employers’ must contribute more today to ensure assets will
grow sufficiently to meet future benefit demands. Higher interest rates mean
employers can contribute less today to reach the same level of assets later.
Looking forward, if the Milliman 100 pension plans were to
achieve the expected 7.5% median asset return for their pension portfolios, and
if the current discount rate of 4.46% were maintained, funded status would
continue to improve over time, with the funded status deficit shrinking to $58
billion (96.4% funded ratio) by the end of 2014 and turning into a surplus of
$34 billion (102.1% funded ratio) by the end of 2015.
The results of the index are based on the actual pension
plan accounting information disclosed in the footnotes of the surveyed
companies’ public financial reporting. In addition to providing the financial
information on the funded status of U.S. qualified pension plans, the footnotes
may also include figures for the companies’ nonqualified and foreign plans,
both of which are often unfunded or subject to funding standards different from
those for U.S. qualified pension plans.
One retirement plan service provider says collective
investment trusts (CITs) can be a powerful answer to demand for customized
target-date vehicles and less expensive investment strategies.
For those who need a crash course in CITs, Kent Buckles,
executive vice president of retirement strategies for Reliance Trust, says the
products often serve as an alternative to mutual funds. CITs are investment
vehicles in which assets from multiple plans can be commingled into one
trust.Each CIT is managed professionally on behalf of those plans and not open
to the public. For that reason, they’re only available as an investment option
within employer-sponsored plans that have negotiated an agreement with the CIT
provider.
Another defining characteristic of CITs is that they are
regulated more as a banking product than an investment fund, Buckles says.
Therefore the products fall under the oversight of state banking regulators and
the federal Office of the Comptroller of the Currency (OCC), rather than the
Securities and Exchange Commission (SEC). The OCC regulators are rigorous in
their examinations of trust companies and CITs, he says, but providers in the
space are advantaged in that the OCC requires less documentation and pre-approval
compared with the SEC.
Buckles says the appeal of CITs for plan sponsors and
fiduciaries is generally a lower expense profile and an improved ability,
especially for larger plans, to create unique investment funds that address the
needs of real plan participants in a more refined way then retail target-date
funds. This can be accomplished because the sponsors can work directly with
fund managers to discuss and meet the investing needs of their participants,
factoring real-world demographic data into portfolio design decisions. Mutual
funds, on the other hand, tend to make portfolio decisions based on much wider
demographic considerations.
CITs
have historically been used in defined benefit (DB) plans and in the larger
defined contribution (DC) and profit sharing plans. DC plan sponsors moved away
from CITs as retirement plan administration moved to daily valuation. CITs
weren’t priced daily or traded daily, but that issue has disappeared. Today
CITs trade on the same platform as mutual funds. Internet connectivity allows
plan participants to track performance of their CITs on a daily basis.
“The growth really isn’t all that different from what you
see happening in other parts of the industry, which is to say it’s strong,”
Buckles tells PLANADVISER. “You never know exactly what the numbers are in
total, but based on the research that we see, the growth seems to be pretty
dramatic for collectives overall. Especially within the defined contribution
space and among more of the smaller plan segments.”
A 2013 survey by financial research and consulting firm
Celent found, from 2006 to 2010, the share of collective trusts as a percentage
of the defined contribution market doubled—from 10% to 20%. In actual dollars,
the jump was from $400 billion to $900 billion, the survey report, “The Defined
Contribution Market,” noted.
At Reliance Trust, assets in CITs have grown from a small
portion of the firm’s $100 billion in total assets under management to about $6
billion since the firm first introduced a CIT product more than a decade
ago—with most of the growth coming from a significant acceleration in the last
three years. Buckles says Reliance’s developments in the field have largely
paralleled the wider industry movements, both in terms of annual growth and the
type of products that sponsors are interested in.
“The first collective fund we offered was a stable value
fund—and we have stable value funds that we still sponsor,” Buckles says.
“Beyond that, we have moved into offering funds in the fixed-income space, real
estate, and stand-alone large cap equity funds, and of course the target-date
offerings are becoming increasingly popular.”
In general, Buckles says the streamlined reporting
requirements and the elimination of excess administration possible through a
collective trust arrangement allows participants to access diversified
investment funds at a 10 or 15 point discount compared with mutual funds that
take similar strategies. He has seen examples where plans have been able to
replace actively managed mutual fund options with more passive-based CITs,
cutting as much as 50 basis points from investment costs.
Another
point Buckles is quick to make about CIT growth is that it’s not just coming
from the large DC plans and big pension funds that have traditionally had the
asset-muscle to benefit from economies of scale via access to preferred share
classes.
“In the smaller plans, what’s attractive about the
collectives is that because they are comingled, you don’t have the limitations
that you’ll have with an institutional fund on the mutual fund side,” Buckles
explains. “So if you want to offer a low-cost institutional mutual fund, usually
you’re going to have some type of a minimum amount before you’ll be able to
invest in the best share classes. You don’t have that issue with the collective
arrangement.”
That’s because the trust company providing the CIT serves as
both the fund trustee and administrator—delivering many of the pieces that are
required to bring the products to participants and the marketplace, such as
daily valuations, fund fact sheets, Morningstar updates, and all the related
legal documentation. When all of those functions are brought under one roof,
they can be done more efficiently.
“So we are the manufacturer, not so much the distributor,”
Buckles explains. “Though we do have some wholesalers that talk to advisers
about our offerings, generally speaking the distributors are really the
recordkeeping platforms, the independent advisers, etc.”
Buckles says plan sponsors also tend to be attracted to the
fact that, in its role as a trustee of assets earmarked for a CIT arrangement,
the provider becomes a plan fiduciary.
“For
that reason, we’re directly liable if there’s anything that’s found that’s not
in compliance with the OCC regulations,” Buckles says. “That’ means we’re
aggressively self-policing, and each of our funds has to be audited by a third
party at least once a year.”