Coronavirus Creates Perfect Storm for DB Plan Funded Status Drop in February

What happened to interest rates is just as important as what happened to equity markets, and DB plan sponsors should implement portfolios that manage both.

Pension funding ratios decreased throughout the month of February, with changes primarily attributed to declining Treasury yields and poor equity performance. Legal & General Investment Management America (LGIMA) estimates that the average plan’s funding ratio decreased 5.3% to 74.4% throughout the month.

The firm notes that the coronavirus outbreak became the primary focus for equity markets in February. But it points out that the outbreak continued to dominate the rates narrative as well, as fears of a full blown pandemic further slowed domestic and global growth. LGIMA’s calculations indicate the discount rate’s Treasury component fell by 36 basis points while the credit component widened 19 basis points, resulting in a net decrease of 16 basis points. Overall, liabilities for the average plan increased approximately 2.7%, while plan assets with a traditional “60/40” asset allocation decreased by approximately 4.1%.

Sources stressed the importance of risk management investment strategies, but also diversification of equities. River and Mercantile Solutions says in its Monthly Retirement Update that plans with the greatest exposure to equities generally saw the largest funded status declines because of the equity market drops at the end of the month. Still, allocations which are largely liability matched saw see a drop in funded status for the month based on the magnitude of the equity market movements.

“So far in March, those declines have continued with the 10-Year Treasury falling below 1% for the first time and equity markets substantially off. While spreads have widened, pension discount rates are still down from the beginning of the month. Plan sponsors with significant liability matching strategies will weather this storm, however plans with any equity exposure will feel the effects. If the coronavirus is comfortably contained in the near future, markets will most likely rebound quickly; if the containment is prolonged, we will almost definitely see continued strain and volatility. This type of economic environment is exactly why plan sponsors need to have a comprehensive funded status risk management strategy that encompasses not only interest rates, but equity exposure as well,” says Michael Clark, managing director at River and Mercantile.

Brian Donohue, partner at October Three Consulting, says, “Falling stock markets grab the headlines, but unprecedented low interest rates are at least as significant a story. For pension sponsors, the combination is a real gut check.” Both model plans the firm tracks lost ground. Plan A lost more than 5%, ending the month almost 10% lower than at the end of 2019, while Plan B slipped 2% and is now down 3% for the year. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

According to Northern Trust Asset Management (NTAM), the average funded ratio of corporate pension plans declined sharply in February from 85.5% to 81.3%. Global equity market returns were down approximately 8.1% during the month, it says. Average discount rate decreased from 2.48% to 2.3% during the month, leading to higher liabilities.

Jessica Hart, head of the OCIO Retirement Assets Practice at Northern Trust Asset Management, notes, “Diversifying assets have provided some downside protection from the broad equity decline. In particular, low volatility strategies, infrastructure and high yield bonds have performed better than a global equity portfolio.”

The aggregate funded ratio for U.S. corporate defined benefit (DB) plans sponsored by S&P 500 companies decreased by 3.9 percentage points in February to end the month at 81.7%, according to Wilshire Consulting. The aggregate funded ratio is estimated to have decreased by 6.9 and 8.8 percentage points year-to-date and over the trailing 12 months, respectively, and now stands at its lowest levels since December 2016.

Ned McGuire, managing director and a member of the Investment Management & Research Group of Wilshire Consulting, says, “February marks the second consecutive monthly funded ratio decrease and the largest consecutive monthly decline in funding levels to begin a year since Wilshire began tracking in January 2013.”

The estimated aggregate funding level of defined benefit (DB) plans sponsored by S&P 1500 companies decreased by 5% in February to 79%, according to Mercer. As of February 29, the estimated aggregate deficit was $527 billion, an increase of $125 billion from the $402 billion measured at the end of January.

The S&P 500 index decreased 8.41% and the MSCI EAFE index decreased 9.23% in February. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased from 2.85% to 2.65%.

“Pension funded status has decreased by 9% since the beginning of the year as equity markets took a dive in late February and interest rates hit yet another all-time low,” says Matt McDaniel, a partner in Mercer’s Wealth business. “Concerns around the global economy loom with the coronavirus spreading around the world, illustrating just how quickly markets can react. Plan sponsors should continue to review their investment policies and consider adopting de-risking strategies as appropriate to ensure gains are locked-in when funded status improves in order to provide protection during economic downturns.”