Pension Plan Funding Falls with Interest Rates, Equity Values

June 7, 2010 (PLANSPONSOR.com) - The financial health of pension plans has suffered an $84-billion setback over the last two months caused by concurrently falling interest rates and equity values, according to the latest estimate from Mercer.

A Mercer news release said the funded status of pension plans sponsored by the S&P 1500 companies was 79% at the end of May compared to 84% at the end of March. This is equivalent to an increase in aggregate pension deficits over the two-month period of $84 billion, from $252 billion at the end of March to $336 billion at the end of May.   

“On average plan sponsors still have about half of their assets invested in equities, so the 7% fall in equity values over the last two months has adversely affected plan assets,” said Adrian Hartshorn, a partner in Mercer’s Financial Strategy Group, in the news release. “Additionally, AA bond yields have also declined by between 0.1% and 0.2% since the end of March, increasing the value of plan liabilities. The combined effect of the fall in equity values and the fall in AA bond yields is a five percentage point decline in funded status.”  

The weighted average asset allocation of U.S. plans sponsored by S&P 1500 companies was 50% equities, 38% fixed income, 3% real estate, and 9% other as of the end of 2009 (see Pension Plans only Slightly Healthier). Based on plan sponsors’ current asset allocations, and given the underlying variation of equity prices and AA bond yields, Mercer said changes in funded status should be expected. For example, based on market conditions at the beginning of the year, Mercer has calculated that the 90% confidence interval for year-end funded status is between 66% and 107%.  

“A change in funded status of plus or minus 20%, as is needed to capture 90% of anticipated year-end funded status outcomes, requires some significant market changes. As a rule of thumb, for each 0.25% fall or rise in AA bond yields, funded status would change by around 1.5% ($21 billion) and for each 5% fall or rise in equity markets there would be a change in funded status of around 2.5% ($35 billion). Plan sponsors often discount these outcomes when considering pension plan risk, but it is these risks that are more likely to result in financial stress,” explained Hartshorn.

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