According to a UBS press release, the typical U.S. pension fund started 2009 with a funding ratio of approximately 78% and ended the quarter higher at approximately 84%. This makes up for only a little of the 24% decline reported by UBS for the fourth quarter of 2008 (see DB Plans Suffer Sharp Funding Decline in Q408 ).
UBS said the increase is attributable to higher discount rates which led to a lower present value of pension liabilities. Corporate credit spreads widened while interest rates rose, which led to a higher corporate bond yield curve and pension discount rate.
The decrease in liabilities was partially offset by volatile equity markets that finished the quarter lower, which decreased the value of the asset pool from which plan participants’ benefits are paid, the announcement said.
For the quarter, pension discount rates (which are based on the yield of high quality investment grade corporate bonds) for a typical pension plan increased over 100 basis points during the quarter, which decreased the present value of pension liabilities. This decrease was offset slightly by interest cost. For the quarter, the overall liability return was -14%, UBS added.
“As plan sponsors consider implementing an interest rate hedging approach, it is imperative that they have a strategy in place to implement the hedge as a function of interest rate, funding ratio and calendar triggers,” suggested Aaron Meder, UBS Global Asset Management’s Head of Asset Liability Investment Solutions in the Americas, in the announcement. “For example, as interest rates begin to increase, plan sponsors should add duration to their portfolios via long duration bonds and/or interest rate derivatives to lock in their funding ratio gains (as the present value of liabilities fall faster than the value of assets) while reducing funding ratio risk.”