Corporate pension plans experienced some correction in March as the average funded ratio declined from 87.2% to 85.6%, according to Northern Trust Asset Management.
The higher liabilities from lower discount rates have more than offset the positive gains in the equity market. Global equity markets were up approximately 1.3% during the month. The average discount rate decreased from 3.79% to 3.50% during the month. This led to higher liabilities.
Mercer estimates the aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 2% in March to 88%, as a result of a decrease in discount rates. As of March 31, the estimated aggregate deficit of $273 billion increased by $56 billion as compared to $217 billion measured at the end of February.
The S&P 500 index increased 1.94% and the MSCI EAFE index increased 0.74% in March. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased from 4.09% to 3.78%.
“The yield curve continues to flatten, which has put downward pressure on the discount rates used by pension plans to value their liabilities,” says Matt McDaniel, a partner in Mercer’s Wealth Business. “These lower rates drove an increase in liabilities, which outweighed gains in the equity market. The yield curve has also briefly inverted on several occasions recently. This signals potential danger ahead in financial markets—inversions have historically been a reliable indicator of a future recession. Plan sponsors should make sure their investment strategy and risk management plans are in order to prepare for a potential storm ahead.”
October Three also notes in its March 2019 Pension Finance Update that pension finances slipped in March due to falling interest rates. Both model plans it tracks lost ground last month: Plan A dropped more than 2% but remains up 2% for the year, while Plan B lost close to 1% but remains ahead 1% through the first three months 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.
Looking ahead, Brian Donohue, partner at October Three Consulting, says, “Pension funding relief has reduced required plan funding since 2012, but under current law, this relief will gradually sunset by 2022, increasing funding requirements for pension sponsors that have only made required contributions. Discount rates fell by more than 0.25% last month. We expect most pension sponsors will use effective discount rates in the 3.6% to 4.0% range to measure pension liabilities right now.”
The aggregate funded ratio for U.S. corporate pension plans decreased by 2 percentage points to end the month of March at 86.7%, according to Wilshire Consulting. The monthly change in funding resulted from a 4.2% increase in liability values, partially offset by a 1.9% increase in asset values. The aggregate funded ratio is up 2.2 percentage points year-to-date, but down 0.5 percentage points over the trailing twelve months.
According to Aon, S&P 500 aggregate pension funded status decreased in March from 88.5% to 87.8%. Pension asset returns were positive throughout most of March, ending the month with a 2.1% return. The month-end 10-year Treasury rate decreased by 32 bps relative to the February month-end rate and credit spreads widened by 10 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 3.76% to 3.54%. The increase in pension liability caused by decreasing interest rates negated the positive effect of asset returns on the funded status of the plan.
Pension funded status in Q1 2019
However, during the first quarter of 2019, the aggregate funded ratio for U.S. pension plans in the S&P 500 increased from 86.0% to 87.8%, according to the Aon Pension Risk Tracker.
Pension liabilities increased as interest rates were down during the quarter. Ten-year Treasury rates decreased by 28 bps over the quarter and credit spreads narrowed by 7 bps, resulting in a 35 bps decrease in the discount rate over the quarter for an average pension plan.
Return-seeking assets rose sharply during the first quarter, with the Russell 3000 Index returning 14%. Bond performance was positive during the first quarter, with the Barclay’s Long Gov/Credit Index returning 6.5% over this timeframe. Overall pension assets were up 7.5% over the quarter.
River and Mercantile notes in its recent retirement update that although the month of March gave back some of the funded status gains since the beginning of the year, for most plans, gains since the beginning of the year should still be up by about 1% to 2%. Equities added to 2019’s strong returns, with global equities up over 10% year to date. The fall in discount rates and the corresponding increase in liabilities remind us of the impact that changes in rates have on a pension plan’s funding status.
Barrow, Hanley, Mewhinney & Strauss, LLC, a value-oriented investment manager, has estimated that corporate pension plan funded ratio rose to 89.2% as of March 31, 2019, from 84.2% as of December 31, 2018. Asset gains drove the increase in funded ratio, but also several plan sponsors reported making volunteer contributions, which increased the average funded ratio. Liabilities rose during the quarter, partially offsetting these funded ratio gains.
Legal & General Investment Management America, Inc. (LGIMA) announced in its Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate defined benefit (DB) pension plan, that pension funding ratios increased over the first quarter of 2019. LGIMA estimates the average funding ratio improved from 84.4% to 85.6% over the quarter based on market movements.
The Pension Fiscal Fitness Monitor shows that global equity markets increased by 12.33% and the S&P 500 increased 13.65%. Plan discount rates decreased by 42 basis points, as Treasury rates decreased 23 basis points and credit spreads tightened 19 basis points. This resulted in a 7.04% increase in plan liabilities. Overall, plan assets with a traditional “60/40” asset allocation rose 8.54%, resulting in a 1.18% increase in funding ratios over the first quarter of 2019.
Ciaran Carr, senior solutions strategist at LGIMA, said, “We estimate that funding ratio levels for the typical plan with a traditional asset allocation increased over the first quarter, largely due to assets outperforming liabilities.”
He added, “Many clients continue to focus on hedging interest rate and credit spread risk inherent in plan liabilities. Doing so can help reduce funded status volatility, which is a key metric of risk for many defined benefit pension plans. As clients continue to move along their glidepath, completion management and other custom hedging strategies have increased in popularity across the industry. Tailoring the fixed income more toward the plan’s liabilities has helped develop an outcome-orientated approach to their investment strategy while helping support potential end-game objectives, such as pension risk transfers or self-sufficiency.”
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