The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies remained level in September at 83% as a result of a decrease in equity markets offset by an increase in discount rates, according to Mercer.
“Funded status was flat month over month as equity market declines were offset by a rise in interest rates,” says Scott Jarboe, a partner in Mercer’s Wealth business. “We saw the S&P 500 pull back after reaching an all-time high in August and interest rates rose slightly during the month with the Fed indicating they would keep short term rates low for the foreseeable future. Plan sponsors should review 2021 budgets and understand the sensitivity of pension liability and expense in light of the persisting low rate environment and potential for a pullback in equity markets as we approach the election and end of the year.”
The equity market declines factored into the fall in defined benefit (DB) plan funded status from most estimates. The aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies decreased by 1.1 percentage points in September to end the month at 83.1%, according to Wilshire Associates. September’s 1.1 percentage point decrease in funded ratio resulted from a 1.7 percentage point decrease in asset values partially offset by a 0.4 percentage point decrease in liability values, it says.
“September’s decrease in funded ratio was primarily driven by negative returns for most asset classes, especially U.S. Equity, which snapped five consecutive monthly increases,” notes Ned McGuire, managing director, Wilshire Associates.
The S&P 500 aggregate pension funded status decreased in the month of September from 87.6% to 86.6%, according to Aon’s Pension Risk Tracker. Pension asset returns were mostly negative during the month, ending September with a -1.4% return. The month-end 10-yr Treasury rate decreased by 3 basis points relative to the August month-end rate, and credit spreads widened by 9 basis points. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.34% to 2.40%.
River and Mercantile points out in its monthly Retirement Update that the U.S. stock market hit an all-time high on September 2nd but reversed course and declined close to 4% by month end. Pension discount rates were little changed from the previous month. “Many plans will see funded status deteriorate over the month to varying degrees mainly depending on their level of equity exposure,” it says.
“Market volatility will continue to affect pension plan sponsors between now and the end of the year. That was clear during September and with the U.S. election looming it will most likely continue in October and November,” says Michael Clark, managing director at River and Mercantile. “Pension plan sponsors will want to take stock of how they are hedged against interest rate movements as well as equity market returns. Those that have hedged more will be in an advantageous place going into year-end. It’s never too late to assess funded status risk and develop a plan to address it, especially with the uncertainty around COVID-19, the ramifications of the U.S. election, and the lack of additional pension funding relief.”
The Northern Trust Asset Management September pension funded report notes that the average funded ratio of corporate pension plans declined in September from 83.5% to 82.5%, as negative equity returns more than offset the higher discount rates. Global equity market returns were down approximately 3.2% during the month, while the average discount rate increased from 2.23% to 2.27%.
Jessica Hart, head of OCIO Retirement Practice at Northern Trust Asset Management, says, “As we expect rates to stay low and equity returns to be modest going forward, further improvement in funded ratio may take some time.”
During September, both model plans October Three tracks lost ground, with Plan A dropping 2 percentage points and Plan B slipping 1 percentage point. Stocks pulled back in September, and a diversified stock portfolio lost more than 3% during the month, according to Brian Donohue, a partner at October Three Consulting.
Donohue says, “2020 experience, if it persists, will not increase required contributions until 2022, compounding higher funding requirements due to the fading of funding relief.”
Legal & General Investment Management America (LGIMA) estimates that pension funding ratios decreased approximately 1.2 percentage points throughout September, with the impact primarily due to poor equity performance. Its calculations indicate the discount rate’s Treasury component declined 2 basis points while the credit component widened 6 basis points, resulting in a net increase of 4 basis points. Overall, liabilities for the average plan decreased approximately 0.4 percentage points, while plan assets with a traditional “60/40” asset allocation fell approximately 1.9 percentage points.
Funded Status Increased in Q3
However, LGIMA’s Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, shows that the average pension funding increased from 75.3% to 77.9% over Q3, based on market movements. Equity markets saw a strong rally over the quarter with Global Equities increasing 8.25% and the S&P 500 increasing 8.93%. Plan discount rates were estimated to have fallen by 6 basis points in total. Overall, plan assets with a traditional “60/40” asset allocation increased 5.22 percentage points.
“Volatile times like this show the importance of decoupling risks that can impact pension plan funded status, such as interest rate and credit spread risk. Separating these risks can help plans design and implement a more appropriate LDI [liability-driven investing] strategy. Hedging more interest rate risk through a ‘completion’ framework and avoiding defaults and downgrades through active credit management are two ways that can help improve funded status outcomes in such volatile markets,” says Katie Launspach, senior solutions strategist at LGIMA.
Pension plan funded status, as measured by Insight Investment’s model pension indices, improved during Q3. Insight maintains three model pension indices, each of which aims to reflect the changing funded status ratio for pension plans following different approaches to hedging the same liability profile. The indices illustrate the effect of hedging with core fixed income versus long duration, holding constant a significant allocation to growth assets. All three funding indices saw improvements in funded status in Q3. Rates rose by 3 basis points over the quarter but spreads tightened by 9 basis points, resulting in a 6-basis points fall in discount rates. The LDI and LCAP indices, which contain long duration fixed income, saw the largest improvements in funded status, at 1.8 percentage points and 1.7 percentage points respectively, while the Traditional index saw its funded status improve by 1.4 percentage points.
NEPC, which tracks the funded status of two hypothetical plans, estimates that U.S. DB plans experienced overall gains in funded status in the Q3 2020 amid robust equity returns in July and August. During the quarter, Treasury yields were mostly unchanged while credit spreads contracted, leading to an approximately 1 percentage point increase in estimated liability valuations. In this period, the funded status of a total-return plan increased 3.2 percentage points, also due to the strong showing by equities, outperforming the LDI-focused plan which rose 2.8 percentage points.
Barrow, Hanley, Mewhinney & Strauss estimates that corporate pension plan funded ratios increased to 84.0% as of September 30 from 81.4% as of June 30. The firm says the asset classes that continue to have the highest allocations from DB plans are Long Bonds (29%) and U.S. Equities (28%). Overall investment returns in Q3 averaged 4.3%, while by asset class, returns were 7.7% for Equities, 1.1% for Bonds and 3.3% for Alternatives.
« FRIDAY FUN – October 9, 2020