Pension Funding Slightly Improves in Q4 2012

Legal & General Investment Management America, Inc.’s (“LGIMA”) Pension Fiscal Fitness Monitor indicated funding ratios rose slightly over the quarter, supported by positive equity returns and higher discount rates. Global equities were up approximately 3%, while discount rates were up four basis points. This resulted in the traditional “60/40” funded status increasing by about 1% in value. Pension discount rates rose four basis points as credit spreads tightened seven basis points and Treasury yields increased 11 basis points.

For the full year, pension funding ratios experienced a slight drop of approximately 1%.  LGIMA estimates the average funding ratio to remain in the low-to-mid 70s as of the end of the fourth quarter. 

“In the 2012 fourth quarter, interest rates increased while credit spreads continued to narrow due to strong technical factors and an improving economic landscape,” said Aaron Meder, head of US Pension Solutions at LGIMA. “This is yet another example of the importance of defined benefit pension plans setting their target levels of interest rate hedging and credit spread hedging separately to identify how much of each risk they want to hedge.”

Meder added: “The S&P 500 continued to hover around five-year highs in the recent quarter, yet the average pension plan remains significantly in deficit. With the S&P 500 close to five-year highs following a strong 16% rally in 2012, along with the current low levels of implied volatility in equity option markets (making it cheaper to hedge), we encourage plans to continue to consider protecting against some pullback in equity markets in the new year.” 

The Pension Fiscal Fitness Monitor assumes a typical liability profile and 60% global equity/40% aggregate bond (“60/40”) investment strategy, and incorporates data from LGIMA research and Bank of America Merrill Lynch and Bloomberg.