Increase in Interest Rates Gives DB Plans a Boost in September

Jessica Hart, with Northern Trust Asset Management, notes, “Even though the Fed cut rates by 25 bps, the average liability discount rate climbed by 13 bps. This highlights the reality that for pension plans, movement at the long end of the yield curve is more impactful than the headline Fed rate.”

The average funded ratio of corporate defined benefit (DB) plans improved in September from 82.5% to 84%, according to Northern Trust Asset Management (NTAM). Both positive returns in the equity market along with lower liabilities led to higher funded ratio.

NTAM says global equity market returns were up approximately 2.1% during the month. The average discount rate increased from 2.56% to 2.69% during the month.

Jessica Hart, head of OCIO Retirement Practice, notes, “Even though the Fed cut rates by 25 bps, the average liability discount rate climbed by 13 bps. This highlights the reality that for pension plans, movement at the long end of the yield curve is more impactful than the headline Fed rate.”

According to River and Mercantile’s monthly Retirement Update, long term interest rates saw some of the steepest rises in recent memory in early September, with the 10 year U.S. Treasury yield rising approximately 30 bps in a few days. This increase was not fully sustained for the rest of the month but discount rates did remain higher compared to their multi-year lows achieved in August.

Looking ahead, Michael Clark, director and consulting actuary at River and Mercantile, says, “Plan sponsors most likely experienced a funded status improvement in September; however, October is already shaping up to be another volatile month with discount rates fluctuating higher and lower than where they ended in September and equity markets experiencing more dramatic declines through the first few days of the month.”

October Three’s September 2019 Pension Finance Update reiterates the impact of the longer end of the yield curve. Both model plans it tracks gained ground last month. Plan A’s funded status improved 2% but remains down almost 5% for the year, while Plan B’s funded status was up less than 1% and remains down 1% through the first three quarters 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 with a greater emphasis on corporate and long-duration bonds. “Corporate bond yields rose more than 0.1% in September—the first meaningful upward move this year—providing some relief to pension sponsors. Pension liabilities fell 1% to 2% in September but remain up 14% to 23% for the year, with long duration plans seeing the largest increases,” says Brian Donohue, partner at October Three Consulting.

As for funded status of specific sectors of the S&P, Wilshire Consulting estimates that the aggregate funded ratio for U.S. corporate pension plans sponsored by S&P 500 companies increased by 1.8 percentage points to end the month of September at 84.9%. The monthly change in funding resulted from a 2.1% decrease in liability values partially offset by a 0.1% decrease in asset values.

For the same reasons, the estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased by 2% in September to 84%, according to Mercer. “This reversed some of the deterioration in August, as interest rates bounced back some during September, but they are still near their historic lows.  Plan sponsors should be diligent to review their pension risk stance as there is continued concern with potential late cycle dynamics,” says Scott Jarboe, a partner in Mercer’s Wealth Business.

DB plan funded status down in Q319

Despite September’s increase, the aggregate funded ratio of S&P 500 plans is estimated to be down 2.9 percentage points during the third quarter, Wilshire Consulting estimates. It is down 2.6 percentage points year-to-date and 8.8 percentage points over the trailing twelve-months. 

Barrow, Hanley, Mewhinney & Strauss, LLC has estimated that the average funded ratio of corporate DB plans sponsored by companies in the Russell 3000 fell to 85% as of September 30, from 87.8% as of June 30. Liability increases outpaced asset gains during the quarter causing the decrease in funded ratio.

The company says plan sponsors have diverged in methods to address pension funding headwinds. Approaches have ranged from making voluntary contributions to re-risking asset allocations.

Legal & General Investment Management America’s (LGIMA) Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate DB plan, shows pension funding ratios decreased over the third quarter of 2019. LGIMA estimates the average funding ratio declined from 83.1% to 79.2% over the quarter based on market movements.

Ciaran Carr, senior solutions strategist at LGIMA, says, “The third quarter saw significant volatility in U.S. interest rates. Plans that adopted a well-designed [liability-driven investing] program were likely better protected; as a result, those plans experienced fewer drawdowns in funded status over the period. Adopting a more tailored fixed income allocation through a Completion framework can help protect funded status drawdowns and complement a plan’s de-risking glidepath.”

LGIMA explains that a completion framework enables an LDI manager to take a holistic view of the plan’s overall strategy. A completion portfolio incorporates a plan’s liability cashflows and actuarial discounting methodology to determine the key rate duration profile of the liability. After accounting for external fixed income manager exposures, implementing a custom Treasury portfolio can help a plan meet its hedging objectives across the curve. By minimizing curve risk exposures and completing to target hedging ratios, a plan will be better positioned to mitigate funded status volatility.