Interest Rates Temper DB Funded Status Improvements in May

“The pattern of improvement paused last month owing to a dip in discount rates, but aggregate funded status remains near a four-year high as the long bull market continues to persist,” says Matt McDaniel, a partner in Mercer’s US Wealth business.

During the month of May, the average funded ratio for corporate pension plans declined slightly from 88.5% to 88.4%, according to Northern Trust Asset Management.

The firm says this was primarily driven by the average discount rate declining from 3.83% to 3.77% during the month, and slightly positive returns in return-seeking assets.  Global equity markets were up approximately 0.1% during the month. U.S. equities posted strong gains, but these gains were muted by a decline in Non U.S. equities.

According to Legal & General Investment Management America (LGIMA), funding ratios decreased 0.3% over the month of May due to a slight increase in the discount rate and weak equity returns. It estimates the Treasury component decreased by 11 basis points, while the credit component increased by 8 basis points, resulting in the discount rate falling to 3 basis points. Overall, liabilities for the average plan were up 0.8%, while plan assets with a traditional “60/40” allocation increased by 0.4%.

Wilshire Consulting also estimates a decrease in pension funding rations. The aggregate funded ratio for U.S. corporate pension plans decreased by 0.2 percentage points to end the month of May at 88.4%, according to the firm. The monthly change in funding resulted from a 0.8% increase in liability values partially offset by a 0.7% increase in asset values. The aggregate funded ratio is up 3.8% and 5.8% year-to-date and over the trailing twelve months, respectively.

Other firms that track defined benefit (DB) plan funded status estimate slight increases; however, as Matt McDaniel, a partner in Mercer’s US Wealth business, says, “The pattern of improvement paused last month owing to a dip in discount rates, but aggregate funded status remains near a four-year high as the long bull market continues to persist.”

Mercer estimates the aggregate funding level of pension plans sponsored by S&P 1500 companies increased by 1% in May to 89% at the end of the month, as a result of gains in the equity markets which more than offset a decrease in discount rates. As of May 31, 2018, the estimated aggregate deficit of $245 billion decreased by $9 billion as compared to the $254 billion measured at the end of April.

The S&P 500 index increased 2.2% and the MSCI EAFE index decreased 2.8% in May, Mercer says. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased by 3 basis points to 4.06%.

According to Aon, S&P 500 aggregate pension funded status increased slightly in the month of May from 87.7% to 87.8%.  Pension asset returns were positive during May, ending the month with a 1% return. The month-end 10-yr Treasury rate decreased by 12 bps relative to the April month-end rate and credit spreads widened by 7 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 3.81% to 3.76%. “Given a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates largely offset the positive impact on the funded status resulting from positive asset returns,” the firm says.

However, year-to-date, the aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 85.6% to 87.8%, according to the Aon Pension Risk Tracker. The funded status deficit decreased by $60 billion, which was driven by a liability decrease of $109 billion, offset by asset declines of $49 billion year-to-date.

October Three found both model pension plans it tracks gained ground last month—both traditional Plan A and the more conservative Plan B improved a fraction of 1% in May. For the year, Plan A is 5% ahead, while Plan B is up 1%. 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.

Stocks were mixed but mostly positive in May, the company notes. Corporate bond yields fell about 0.08% at most maturities in May, pushing pension liabilities up 1% on the month.