Bond Yields Help Q308 Pension Funding Picture

October 7, 2008 (PLANSPONSOR.com) - The global equity markets may have spent much of the third quarter heading south, but pension plans' financial position has actually improved during the period, according to a Mercer analysis.

A Mercer news release said the reason was the increase in high-quality corporate bond yields – widely used to measure the value of plan liabilities.

The Mercer analysis found that:

  • the funded status of pension plans sponsored by large U.S. companies has fallen by almost $100 billion since the end of 2007.
  • The ratio of plan assets to plan liabilities, which was 104% at the end of 2007, was 97% at the end of the third quarter. The surplus at the end of 2007 of $60 billion has been replaced by a deficit of $35 billion.

Mercer said without the spike in high-quality corporate bond yields, plans’ financial position would be significantly worse.

If credit spreads return to levels typically observed over the last three to four years, without a recovery in equity values, the deficit could open up to over $400 billion with a 77% funded status. “This would clearly be bad news for sponsors of defined benefit plans, and would lead to higher pension costs in financial statements and higher cash contribution requirements,” Mercer said.

“It is important to understand the relationship between corporate bond yields and pension plan liabilities,” said Adrian Hartshorn, a member of Mercer’s Financial Strategy Group, in the news release.   “Plan sponsors should continue to educate themselves on the risks they are exposed to with their pension plans. Those who have quantified and can withstand short-term volatility are being encouraged to sit tight and maintain a longer term focus. Others may be revisiting their current program financial management policies and considering opportunities to mitigate risk or better position themselves moving forward. While it is difficult to take short-term action, it is also important for plan sponsors to monitor the ever-changing environment and be prepared to take action at the appropriate time.”

«