As the calendar turned from 2017 to 2018, we observed a strongequity market rally, the most significant overhaul of the corporatetax system in a generation, and a strong economy withsimultaneously low unemployment and low inflation. We also observedrising interest rates coupled with a new Federal Reserve chairmanappointed by President Trump. And, early in the year, weexperienced significant capital market volatility.

Many pension plans in the United States have emerged from thiseconomic environment with improved funded status. In fact, theaggregate funded status of pensions at the nation's largestcompanies is currently at its highest level since 2013. (See Figure1, below.)

In our annual study, Willis Towers Watson analyzed the 10-Ks of389 Fortune 1000 companies that sponsor U.S. defined-benefitpension plans with fiscal years ending in December. The aggregatefunded status on an accounting basis improved from 81 percent atthe beginning of 2017 to 83 percent at the end of the year. That'sbecause although pension liabilities climbed last year, assetsclimbed higher.

The largest factor driving up liabilities during 2017 was adecline in the discount rate used to determine the present value ofthe liabilities. (The pension plan discount rate is based on AA,long-duration corporate bond yields.) The impact of the lowerdiscount rate, when combined with other items such as benefitaccruals, benefit payments, and other assumption changes, resultedin an aggregate liability increase in 2017.

On the other side of the pension plan ledger, assets also grew,driven by double-digit investment returns and employercontributions. Investment returns were strong for both equities andfixed income. The average plan return of 13 percent was well abovethe expectation of 7 percent. In addition, employers' contributionsto their plans was up roughly 20 percent in 2017 compared with2016, possibly in response to rising premiums from the Pension Benefit Guaranty Corporation(PBGC). Another driver might have been a desire to accelerate planfunding for tax purposes; a contribution made now, under the oldtax regime, carries a larger tax deduction than a contribution madelater, under the new tax regime. Bottom line: The asset increase outpaced thecorresponding liability increase, leading to the aggregate fundedstatus improvement.

What Does This Mean for Pension Plan Management?

A prudent first step would be to update your evaluation of yourplan's funded status risk. This is generally defined as the risk ofan unexpected and extreme decline in funded status. An improvementin funded status during 2017 might result in either lower or higherfunded status risk. Which way it goes depends on several factors,of which the most significant is the plan's asset allocation. Youshould evaluate any change in funded status risk in terms of itseffect on the plan's objectives and its relation to the riskappetite of both the pension plan and the company overall.

The simplest way to measure funded status risk is to project thefunded status one year out under a baseline set of assumptions thatare consistent with the plan's valuation assumptions. For example,you might assume interest rates won't change and asset returns willremain the same as expected. Next, calculate a separate one-yearforecast that's based on negative capital market assumptions. Forexample, assume a 100 basis point decline in interest rates and a20 percent loss in equity values.

Then compare the two end-of-year funded-status results. Thedifference in projected funded status is the plan's funded-statusrisk. You can perform the same exercise with more precision byusing a statistical model to identify the tail scenario that has a5 percent probability.

The evaluation of funded-status risk might suggest that the plansponsor take certain actions to move the plan closer to itslong-term objectives. Most plan sponsors have financial objectivesthat drive the management policies of the plan, objectives such as“get fully funded” or “reduce plan volatility.” Achieving such afunded-status objective involves trade-offs between risk, time, andcash. A plan sponsor is always balancing:

• Risk: How much investment risk are you willing to bear?
• Time: How long is your time horizon?
• Cash: What are your constraints for contributions?

When the plan's funded status improves, it might make sense toadjust the plan's strategic asset allocation because its riskposture has changed, or possibly in response to a previouslyestablished de-risking glide path. The new tax bill—and, more specifically,its impact on deductions and after-tax costs—might also affect acompany's interest in accelerating contributions. Both of thesetrends mean 2018 may be the year for your plan to execute on asettlement strategy such as purchasing a retiree annuity.

Plan sponsors have multiple strategy levers they may deploy inmanaging pension plan risk, including:

• Asset allocation—Shift between return-seeking assets andliability-hedging assets.
• Contributions—Plan for the minimum required, or accelerate bymaking discretionary contributions.
• Design—Change the benefit formula (e.g., close to new entrants,freeze accruals).
• Settlement—Transfer assets and liabilities, along with theassociated funded-status risk, to another party through a lump sumor annuity purchase.

It is important to note that these strategies are interrelated.Therefore, plan sponsors need to manage them collectively, ratherthan considering each in isolation.

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The Time Is Right to Re-evaluate

Any solution for managing pension plan funded-status risk shouldbe considered as part of a comprehensive strategy that starts withan updated risk assessment and then considers all the multiplestrategic levers that can be pulled upon by the plan sponsor tomove toward the ultimate objective.

The first quarter of 2018 greeted us with discount ratesincreasing almost 50 basis points, creating liability gains, asequity prices became more volatile. Some pension plans may haveseen a small improvement in funded status so far this year, whileothers are undoubtedly experiencing losses after the 2017 gains.Either way, now's the time to assess your plan for possiblemodifications to plan management strategy.

If I were on a pension plan committee, I would take thisopportunity to re-evaluate the plan's risk and establish a holisticplan to manage toward its financial objectives—and these stepsmight result in some strategy changes for 2018.

Gordon A. Young, FSA,MAAA, FCA, EA, is a senior retirement consultant in the Milwaukeeoffice of Willis Towers Watson. Young has 27 years of experiencehelping clients manage their retirement programs. He is acredentialed member of the Society of Actuaries, the AmericanAcademy of Actuaries, and the Conference of Consulting Actuaries,and he earned a bachelor's degree in economics from YaleUniversity.