DB Funded Status Improved in June, but Down for Q2

While asset returns gave defined benefit (DB) plan sponsors a funded status bump in June, lower interest rates led to an overall decline for the second quarter of 2019.

The aggregate funded ratio for U.S. corporate pension plans increased by 0.8 percentage points to end the month of June at 86.4%, according to Wilshire Consulting.

The monthly change in funding resulted from a 3.8% increase in asset values more than offsetting the 2.8% increase in liability values.  “June’s increase in funded ratio was driven by the best performance for June in Wilshire 5000 history,” stated Ned McGuire, Managing Director and a member of the Investment Management & Research Group of Wilshire Consulting.  “June’s 0.8 percentage point increase in funded ratio is the fourth monthly increase this year.”

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased by 2% in June to 87%, as a result of an increase in equity markets which offset a decrease in discount rates, according to Mercer. As of June 30, the estimated aggregate deficit of $308 billion decreased by $31 billion as compared to $339 billion  measured at the end of May.

The S&P 500 index increased 7.05% and the MSCI EAFE index increased 5.97% in June. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased from 3.63% to 3.44%.

According to Northern Trust Asset Management (NTAM), corporate defined benefit (DB) plans’ funded ratio improved from 86% to 87% in June. Global equity market returns were up approximately 6.55% during the month. The average discount rate decreased from 3.27% to 3.06% during the month. This led to higher liabilities, though again these were more than offset by the favorable returns in the equity markets.

While an improvement came during the last month, the drop in discount rates has kept funded status from recovering to the 2019 highs of just below 90%, NTAM notes.

River and Mercantile’s Retirement Update for July says June was another period of volatile market movements as rates continued to fall off the back of the Federal Reserve’s decision to leave base rates unchanged for now. Meanwhile global equity markets had a strong month, with U.S. equity markets in particular reaching all-time highs. For most plans this would have led to an improvement to their funding level, contributing to positive year-to-date performance.

Discount rates decreased sharply in June, dropping 0.18%. Current rates are now down 0.71% since year end 2018 and are 0.63% lower than rates from this time last year. The FTSE pension discount index finished June at 3.51%. According to River and Mercantile, it’s been two years since rates have been this low.

In June, the U.S. market increased by 7% while developed and emerging international markets increased 6%. Interest rates continued to decline while credit spreads narrowed. As a result, bonds increased in value, especially long-dated and more risky segments. High yield bonds were the best performers, increasing 4%.

“When interest rates drop almost 0.20% in a given month it’s hard for pension plans to gain any funded status ground, but that’s exactly what they did in June due to significant asset returns,” says Michael Clark, director at River and Mercantile.

Both model plans OctoberThree tracks gained ground last month. Plan A improved close to 2%, ending the first half of 2019 basically flat, while Plan B added close to 1% and is now up less than 1% through the first six months of 2019. 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 featuring a greater emphasis on corporate and long-duration bonds.

“At the beginning of the year, almost no one foresaw corporate bond yields falling 0.75% or stock markets earning [more than] 15% in the first half of the year, but here we are. As dramatic as these movements have been, the upshot for pensions has been basically a wash,” says Brian Donohue, partner at October Three Consulting.

Funded Status Down in Q2

Despite funded status improvements in June, DB plans lost ground in Q2.

Barrow, Hanley, Mewhinney & Strauss, LLC, a value-oriented investment manager, has estimated that corporate pension plan funded ratio fell to 87.8% as of June 30, from 89.2% as of March 31. Liability increases outpaced asset gains during the quarter, causing the decrease in funded ratio. For plan sponsors reporting annual financials during the quarter, volunteer contributions were lower than those reported in Q1 2019.

Legal & General Investment Management America Inc. (LGIMA) announced today in its Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB pension plan, that pension funding ratios decreased over the second quarter of 2019. LGIMA estimates the average funding ratio declined from 85.6% to 83.1% over the quarter based on market movements.

The Pension Fiscal Fitness Monitor showed that pension funding ratios regressed over the quarter. However, global equity markets increased by 3.80% and the S&P 500 increased 4.30%. Plan discount rates fell 40 basis points, as Treasury rates decreased 32 basis points and credit spreads tightened 8 basis points. This resulted in a 6.79% increase in plan liabilities. Overall, plan assets with a traditional “60/40” asset allocation rose 3.63%, resulting in a 2.53% decrease in funding ratios over the second quarter of 2019.

Ciaran Carr, senior solutions strategist at LGIMA, says, “We have noticed a greater interest from clients in utilizing derivative overlays more holistically across investment strategies. In particular, we have seen a wider interest in equity overlay investment strategies from clients wanting to replicate outright equity exposure, equitize cash, or implement some level of equity protection within their portfolio. Finding ways to efficiently reduce funded status volatility while respecting their de-risking glidepath continues to be a core objective of many defined benefit pension plans. This is in tandem with clients moving into more custom [liability-driven investing] LDI strategies, where a more integrative approach can be adopted across each plan’s investment strategy to help manage and reduce risk where possible.”