Low Interest Rates, Coronavirus Deal Blow to DB Plan Funded Status

Plans with the greatest exposure to equities will generally see the largest funded status declines, according to River and Mercantile.

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios decreased throughout January, with changes attributed to decreasing Treasury yields.

LGIMA’s calculations indicate the discount rate’s Treasury component fell by 38 basis points while the credit component widened 10 basis points, resulting in a net decrease of 28 basis points. Overall, liabilities for the average plan increased 4.56%, while plan assets with a traditional “60/40” asset allocation increased by approximately 0.12%.

River and Mercantile says in its monthly Retirement Update that discount rates for the typical pension plan fell 30 basis points in January. The FTSE Pension Discount Rate Index ended the month at all-time lows (2.8% for an average duration plan).

However, in addition, equity markets started the month strong but took a dive in the final week of January as investors worried about the potential economic impacts of the coronavirus outbreak, River and Mercantile notes. High quality fixed income investments posted the highest returns for the month.

The company says funded status movements will depend on equity allocations, and plans with the greatest exposure to equities will generally see the largest funded status declines. Allocations which are largely liability matched should see a relatively stable funded status for the month.

“January was shaped by the effects of the coronavirus, which caused markets to fall, and a flight to safety, which pushed interest rates towards historic lows the latter half of the month. Currently, equity markets are starting to shrug off the coronavirus, but fixed income markets are still showing signs of caution. Both sides won’t be right, so we expect to see some volatility as the effects of the virus continue to play out,” says Michael Clark, managing director at River and Mercantile.

“Pensions got clobbered in January, as stock markets mostly lost ground while interest rates reached new all-time lows,” says Brian Donohue, partner at October Three Consulting. Both model plans it tracks saw funded status declines last month, with Plan A dropping 4% while the more conservative Plan B lost 1%. 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.

According to Wilshire Consulting, the aggregate funded ratio for U.S. corporate pension plans decreased by 2.3 percentage points in January to end the month at 86.3%. “January’s decrease in funded ratio ended four consecutive months of funded ratio increases and began 2020 with the largest monthly decline in funding levels since August’s four percentage-point decline,” says Ned McGuire, managing director and a member of the Investment Management & Research Group at the firm.

He explains: “January’s decrease in funded ratio was driven by the increase in liability value resulting from a nearly 40 basis point decrease in Treasury yields partially offset by a low double digit basis point increase in credit spreads.”

The aggregate funded ratio for pension plans in the S&P 500 has decreased from 86.6% to 85.5%, according to the Aon Pension Risk Tracker. Aon says pension asset returns were positive throughout January, ending the month with a 1.6% return. The month-end 10-year Treasury rate decreased by 41 basis points relative to the December month-end rate and credit spreads widened by 19 basis points. This combination resulted in a decrease in the interest rates used to value pension liabilities from 2.86% to 2.64%.

“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 offset the positive effect of asset returns on the funded status of the plans,” Aon says.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 4% in January to 84% as a result of a decrease in discount rates and equity markets, according to Mercer. As of January 31, the estimated aggregate deficit of $402 billion increased by $101 billion, compared with $301 billion measured at the end of December.

“January saw a decline in pension funded status, mainly due to underperforming equity markets, lower interest rates and high-quality corporate bond yields dropping to an all-time low,” says Scott Jarboe, a partner in Mercer’s wealth business. “If low rates persist, risk transfer activities such as lump sum windows may be attractive during 2020. As we continue into the new year, plan sponsors should review their pension risk toolkit and explore all of their options.”