The institutional markets spring forward: Emerging trends

What a difference a year makes, especially when it comes to the financial outlook and optimism on the part of businesses, governments and other institutions.

In a turnabout from this time last year with its pandemic-induced economic malaise, spring has bloomed a bouquet of positive financial confidence. Trillions of dollars in government stimulus, rising equity markets, continued historically low interest rates, and increased hiring have combined to create new opportunities for executives and finance managers.

These favorable economic developments are supportive to your organization in addressing an array of financial and risk management needs. The specific opportunities will depend on your financial goals whether related to benefit funding, pension risks, investment options or income solutions.

Managing pension risk

Rising stock market valuations and historically low interest rates are prompting more sponsors of defined benefit pensions to rethink their plan management and risk transfer strategies.

After last year’s market selloff, the stock market has recovered to reach new highs, which in turn has helped many pension plans restore and even improve funding to healthier levels.

Recently, Chief Investment Officer reported that the aggregate funding ratio for the 100 largest U.S. corporate pension plans as tracked by the Milliman 100 Pension Funding Index rose to 92.9 percent, the fifth straight month that ratios improved.¹ Milliman predicted that the funded status of those plans, based on assumptions for the discount rate and funding, would rise to 96.3 percent by the end of 2021, and 100.7 percent by the end of 2022.

The fortuitous convergence of rising funding ratios and historically low interest rates is prompting more pension managers to consider pension risk transfer (PRT), shifting the obligations and inherent risks of pension payments from plan sponsors to life insurance companies. MassMutual is seeing increased interest in PRT across the industry, with the expectation that total industry transaction volume will grow from prior year.

Firms have several options to consider for a PRT transaction, from terminating the entire plan or addressing a subset of participant groups based on payment status or other factors. Additional considerations are whether a company adopts a buy-in by purchasing a group annuity that remains as an asset within the plan or chooses a buy-out to fully transfer its obligations to an insurer.

Reviewing retirement plan investment options

Two notable investment trends are creating increased consideration among sponsors of defined contribution plans: collective investment trust (CIT) and sustainable investing, otherwise referred to as environmental, social and governance (ESG) investing. Let’s look at each separately.

CIT

CITs are pooled investment vehicles similar to mutual funds but tax exempt and sponsored and maintained by a trustee bank or trust company. These vehicles have become increasingly popular within the institutional market amongst plan sponsors because of their relatively low expenses.

CITs are only available to certain qualified retirement plans, like 401(k)s. The trustee of a CIT is responsible for managing and overseeing the investment of a fund’s assets as a fiduciary in accordance with ERISA’s responsibility provisions. CITs are not registered with the SEC, allowing them to operate without the cost of maintaining an independent board of directors. Instead, CITs are subject to regulation and oversight by state regulatory agencies, particularly the Office of the Comptroller of Currency, as well as the IRS and DOL.

While there are many benefits to a CIT, they are not right for every plan, and mutual funds continue to make sense for defined contribution plans. These types of determinations need to be made on a case-by-case review with a qualified financial professional.

MassMutual has a commitment to supporting the retirement industry. Several of our investment strategies are available as both a mutual fund and a CIT under the MassMutual Investments brand.² Once an investor has found an investment solution that works for their needs, we can work with their retirement advisor to provide those solutions.

ESG

Meanwhile, ESG investing continues to gather increased interest from institutional investors. ESG investing in the U.S. reached $250 billion in assets under management as of December 31, 2020 and is expected to continue growing, according to a report by Chapman and Cutler.³

ESG investing adheres to a philosophy of “doing well by doing good”. The approach holds companies responsible for sustainable management practices that protect the environment, promote social welfare, and adhere to ethical governance.

The ESG marketplace continues to grow as investors increasingly adopt screens that emphasize ESG practices. Sustainable investment practices are impacting corporate governance, not only from an investment perspective, but also whom companies choose to do business with in all aspects of their operations.

MassMutual’s emphasis on mutuality – working together for the common good – is uniquely positioned to align with ESG principles. Check out some of our more recent initiatives regarding net zero climate change actions and our commitment to responsible investing. These commitments expand upon the company’s existing sustainability activities and are rooted in our founding principles going back 170 years.

Funding employee benefits

As companies emerge from the financial challenges posed by this past year, they are embracing new growth opportunities and new ways to put their money to work. The corporate-owned life insurance (COLI) and bank-owned life insurance (BOLI) markets align with these needs more than ever before.

Banks and corporations have traditionally purchased life insurance on their key executives to protect against the loss of talent and expertise due to a premature death, as well as a vehicle to help fund benefit programs. Sometimes, COLI and BOLI policies enable companies to offer benefits that they might otherwise be unable to fund.

The best example of this practice is the use of BOLI and COLI as a means of funding non-qualified deferred compensation programs. A portion of the premium paid on a COLI policy is earmarked for a cash value account, which accumulates tax-deferred until the funds are withdrawn from the policy. Using BOLI and COLI enables many companies to protect themselves from the loss of key talent while providing a highly efficient means of compensating talented leaders.

The coming economic recovery

As America emerges from the pandemic and its related financial downturn, economists and business leaders are expressing very high optimism about a coming economic boom. The U.S. Federal Reserve in the first quarter predicted that the U.S. gross domestic product (GDP) is expected to increase 6.5 percent in 2021, sharply higher than the forecast in the previous quarter.⁴

The economy’s gathering momentum is generating new opportunities for America’s businesses, governments and other institutions to achieve enhanced financial security and stability. MassMutual remains ready as always to help institutions to make the most of the opportunities that emerge.

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Keith McDonagh is Head of the Institutional Solutions businesses for Massachusetts Mutual Life Insurance Co. (MassMutual), which includes Institutional Insurance, Pension Risk Transfer, MassMutual Investments, and Funding Agreements.