The 9.1% decline in the Towers Watson Pension Index for September was the worst monthly result since August 1998. The Towers Watson Pension Finance Watch report says the resulting index value of 59.7 represents a 15.6% decline for the year and a new all-time low in the firm’s 20+ year data series.
The benchmark equity portfolio provided a -8.1% return for September, and has now returned -18.6% over the trailing five months. Meanwhile, declining yields brought another month of strong fixed income returns.
The capital market’s “flight to quality” continued in September, with long Treasury yields dropping 70 basis points while long corporate yields moved down 35-40 basis points. According to the report, the resulting credit spread of about 170 basis points is the largest in over two years.
The Towers Watson Pension Index tracks the performance of a hypothetical pension plan invested in a 60% equity/40% fixed income portfolio. This portfolio recorded a -4.6% return for September. Monthly returns on the 80% and 40% equity portfolios also tracked by Towers Watson were -6.3% and -2.8%.
Pension plan liabilities as defined for U.S. accounting purposes are typically measured based on yields available on high quality corporate bonds as of the measurement date. Using Towers Watson’s RATE:Link methodology, which matches yields on high quality corporate bonds to projected cash flows, the benchmark discount rate was determined at 4.61% – down 40 basis points for the month and 76 basis points for the year.Similar to bond prices, values for pension obligations move in the opposite direction of interest rates. Towers Watson’s liability index (based on projected benefit obligations) increased 5.3% for the month, reflecting the combined impact of interest accumulation and the decrease in the discount rate.
In order to capture real-world effects, Towers Watson supplements its Pension Index results with a report on the financial condition of the pension plans provided by the 300 companies that comprise the TW 300.
The funded position of the TW 300 companies improved slightly during 2010, as unfunded liabilities declined slightly and the aggregate funded ratio improved by 2.4 percentage points. Strong investment returns and a high rate of plan sponsor contributions outweighed the impact of a decline in interest rates, which pushed up liability values, according to the Towers Watson Pension Finance Report.
Favorable results continued for the first half of 2011. The aggregate funded position improved by $66 billion, which equated to an estimated 3.6 percentage point increase in the aggregate funded ratio as of June 30. But those good times ended with a calamitous third quarter, as plunging equity values knocked down asset portfolios and a major decline in interest rates pulled up liability values.
While a relatively high rate of employer contributions is still anticipated for the year, the beneficial effect is far outweighed by the fallout from these capital market events, Towers Watson said. The firm estimates that after three quarters of 2011 the unfunded liability amount has grown by $231 billion and the aggregate funded ratio has declined by 10.3 percentage points.The full report is available at http://www.towerswatson.com/assets/pdf/5604/PFW_Sept-2011.pdf.