The funding status of defined-benefit pension plans has been lifted by rising interest rates, which are expected to increase further

Rising interest rates are boosting corporate pension plans, providing finance chiefs with an option to lighten their companies’ balance sheets and transfer obligations to insurers.

The U.S. central bank has raised interest rates five times this year as it battles persistent high inflation, including last week when it opted for the third consecutive 0.75-point interest-rate increase and indicated further rate action.

When interest rates rise, liabilities for defined-benefit plans—a type of pension plan that promises fixed amounts to participants—shrink. The liabilities are based on long-term corporate bond yields and decrease when bond yields rise. Long-term corporate bond yields rose to 4.7% at the end of August, up from 2.76% at the end of 2021 and 2.58% a year ago, according to Mercer LLC, a consulting firm.

Defined-benefit plans sponsored by S&P 1500 companies were 101% funded as of Aug. 31, up 6 percentage points from the prior-year period, according to Mercer. Discount rates are forecast to keep climbing, which would increase funding levels even more and make it more appealing for companies to shift their obligations.

Many companies in recent years have closed their defined-benefit plans to new entrants and signed them up to defined-contribution plans instead. Those plans don’t guarantee fixed payouts, relieving companies from the pressure to generate certain returns and the costs associated with managing the pensions.

Companies need to have a fully funded pension plan to transfer it entirely to a third party, a process that usually takes one or two years. They can also move just a portion of their pension obligations, but that still requires a high funding status.

Finance executives and plan sponsors are preparing to unload their plans now as funding levels are high, advisers said. “If interest rates level off or decrease, the funded status could fall pretty quickly,” said Matt McDaniel, a partner at Mercer who advises companies on pension risk transfers. That could limit companies’ ability to transfer their plans.

International Business Machines Corp. this month said it is moving more than 40% of its defined-pension obligations—about $16 billion—off its books. The technology company is splitting the liabilities equally between insurers Prudential Financial Inc. and MetLife Inc. in a transaction that closed Sept. 13. The plan was funded at 112% at the end of last year, and will remain more than fully funded after the transaction, the company said. IBM declined to comment further.

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