Pension Gap Narrows Worldwide

December 20, 2005 (PLANSPONSOR.com) - Strong equity returns and higher bond yields in many countries combined to produce the best overall quarter for the funded status of defined benefit plans in more than two years, according to a Towers Perrin analysis.

Funding levels of benchmark pension plans increased in all the countries studied during the third quarter of 2005, according to the latest analysis, led by especially large increases in Brazil, Japan, and the US.   The funded status of DB plans in the US improved in the third quarter largely because rising interest rates reduced liabilities for plan sponsors, according to Towers Perrin Global Capital Market Update: Third Quarter 2005.   While higher bond yields had a negative impact on pension assets, this was more than offset by relief on the liability side of the balance sheet, and the combined effect resulted in a five percentage point improvement in the PBO funded ratio of the benchmark plan to end the quarter at 82%.  

Towers Perrin noted that equity markets continued to benefit from strong performances by energy-related stocks as well as positive economic news, particularly outside the US.   In fact, all of the markets measured in this analysis recorded double-digit equity returns for the 12 months ending September 30, 2005.   Bond yield movements varied, but the general movement was higher, resulting in higher discount rates and slightly lower pension liabilities.  

Best in a Long Time

“This was one of the best quarters we’ve seen in a long while,” said Martine Ferland, a Towers Perrin principal with the firm’s HR Services business Global Consulting Group. “It’s been a relatively uncommon phenomenon in recent years for rising bond yields and very strong equity results to combine simultaneously, but it certainly happened in the third quarter. Defined benefit plans around the world clearly benefited from these capital market movements.”

The report, which covers DB pension plans in Australia, Brazil, Canada, the Euro-zone, Japan, the U.K. and the US, also noted that, on average, benchmark plans remain substantially underfunded, although capital market movements this quarter helped improve the situation — most notably in Australia, Brazil and Japan.

Country highlights:

Australia : The Australian stock market surged to record levels, with investors witnessing a 10% return on domestic equities.   Currency movements and fixed interest- returns were relatively flat over the quarter and had little effect on the positive results.   Largely in response to expectations that higher energy prices would eventually trigger inflation, bond yields rose both domestically and internationally, resulting in a reduction in pens ion liabilities. In fact, the combination of lower pension liabilities and higher asset values increased the PBO funded ratio of the benchmark plan to 87% at the close of the quarter.

Brazil : Inflation pressures that plagued Brazil earlier this year subsided marginally in the third quarter, and the country’s central bank reduced its lending rate by 25 basis points, to 19.5%. The Brazilian equity markets responded enthusiastically to the rate cut and recovered from a poor first half to post a 25.6% return, according to the report. Although short-term interest rates declined, long-term interest rates rose in the third quarter, resulting in a higher discount rate and thus lower pension liabilities – the combined effect was an increase of 12 percentage points in the funded status of the benchmark plan, resulting in the PBO funded ratio moving above the fully funded level to 106% as of September 30, 2005.

Canada : The Canadian equity markets experienced strong growth in the third quarter, however, the rising value of the Canadian dollar hampered returns for unhedged domestic investors, leading to only modest international equity returns overall, according to the study.   In contrast to most other markets, Canada’s bond yields declined slightly, prompting a reduction in the benchmark discount rate for a fifth consecutive quarter, to 5.05%, and an increase in pension liabilities.   Overall, higher asset values outweighed the impact of the increase in liabilities, and the PBO funded ratio rose slightly from 71% to 72%.

Euro-zone : Equity markets in the Euro-zone continued to post strong gains in the third quarter, and foreign equity investments also performed well.   However, bond yields saw little movement over the quarter, which left pension liabilities unaffected and the benchmark discount rate unchanged at 3.9%. Strong returns in the Euro-zone equity markets resulted in a 2 percentage point improvement in the PBO funded ratio of the benchmark plan, to 75%.

Japan : Soaring stocks brought a return of 20.5%, leading to the strongest performance for pension plan assets since the second quarter of 2003 here.   Long-term nominal bond yields rose to their highest levels in 12 months, and the Bank of Japan continued with its zero interest-rate policy.   Overall, the PBO funded ratio of the benchmark Japanese plan jumped to 72%, up a full 8 percentage points from the second quarter.  

United Kingdom : British equity markets posted solid gains and returned 8.2% in the quarter, and DB plans benefited from these positive investment returns.   The PBO funded ratio rose 2 percentage points, to 83%, by the close of the quarter, but the movement in bond yields caused the benchmark discount rate to be revised slightly upward.   Under normal circumstances, this would reduce pension liabilities, but in the third quarter this effect was offset by a slight rise in the salary inflation rate.  

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