Equity Returns Gave Pension Funding a Boost in July

Providers that track pension funding status note that interest rates could affect funding levels for the rest of this year.

The aggregate funded ratio for U.S. corporate pension plans increased by one percentage point to end the month of July at 84.3%, up 8.3 percentage points over the trailing twelve months, according to Wilshire Consulting.

Wilshire attributes this to a 1.3% increase in asset values, which was partially offset by a 0.3% increase in liability values. Year-to-date, the aggregate funded ratio is up 2.4 percentage points.

“July’s increase was driven by the increase in asset values resulting from positive returns for most asset classes as equity indices notched multiple record closes throughout the month,” says Ned McGuire, vice president and a member of the Pension Risk Solutions Group of Wilshire Consulting.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies also increased by 1% to 83% in July, as positive equity markets were offset by a decrease in discount rates, according to Mercer, a wholly owned subsidiary of Marsh & McLennan Companies. As of July 31, the estimated aggregate deficit of $404 billion represents a decrease of $12 billion as compared to the deficit measured at the end of June. The aggregate deficit is down $4 billion from the $408 billion measured at the end of 2016.

“Interest rates finally stopped their fall, allowing equity gains to drive a modest improvement in funded status,” says Matt McDaniel, a partner in Mercer’s Wealth business. “But rates remain depressed, and are still only 40 basis points above their 2016 lows. Rising rates would help funded status, plan sponsors will need a plan to capture these gains, or else they will continue to face significant risk.”

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios increased 1.1% over the month of July, from 82.8% to 83.9%, with gains driven mainly by a strong month in the global equity markets and minimal changes to pension discount rates. LGIMA estimates Treasury rates increased 4 basis points while credit spreads tightened 6 basis points, resulting in the discount rate falling 2 basis points. Overall, liabilities for the average plan were up 0.6%, while plan assets with a traditional “60/40” asset allocation increased by 1.9%.

NEXT: Year-to-date funding improvement and expected discount rates

Northern Trust says the month of July saw the average funded ratio for corporate pension plans increase modestly from 81.8% to 82.4%.

This increase can be attributed to the following factors:

  • Global equities returned 2.8%;
  • Interest rates declined slightly from 3.77% to 3.75% during the month.  Declining interest rates lead to higher liabilities; and
  • The favorable asset returns were slightly offset by higher liabilities, resulting in a modest increase to the funded ratio.

According to Northern Trust, the funded ratio has improved from 80.0% at the end of 2016 due to positive equity returns outweighing the decline in discount rates. The average plan discount rate has declined 25 basis points. Thus far, 2017 has been a story of global growth: Equity returns have been strong, returning 15.0% for global stocks; led by non-U.S. equities returning more than 18%.

The aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 80.9% to 81.7%, year-to-date, according to the Aon Hewitt Pension Risk Tracker. The funded status deficit decreased by $1 billion, which was driven by asset growth of $81 billion, offset by a liability increase of $80 billion year-to-date.

October Three also says strong stock markets have buoyed pension sponsors this year, overcoming lower interest rates to produce improvements in pension funded status, and July saw a continuation of this trend. Both model plans it tracks enjoyed modest (less than 1%) improvement last month and remain in the black for the year so far. Traditional Plan A is now up more than 2% this year, while the more conservative Plan B is ahead 1% through the first seven months of 2017.

Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

October Three notes that Congress passed a budget in 2015 that includes a third round of pension funding relief since 2012. The upshot is that pension funding requirements over the next several years will not be appreciably affected by current low interest rates (unless these rates persist). Required contributions for the next few years will be lower and more stable than under prior law.

Discount rates moved down a couple basis points last month. October Three expects most pension sponsors will use effective discount rates in the 3.5% to 4.1% range to measure pension liabilities right now. More information is here.