“If [rising equity markets and bond yields] were to continue … you could see funded status move up pretty notably,” Michael Moran, pension strategist at GSAM told PLANSPONSOR. Some corporate plan sponsors could finally see funded levels rise in 2013, which will allow them to move up their glide paths and implement de-risking strategies that may have been on hold in the low interest rate/low funded level environment over the past few years, according to a GSAM white paper, “Pension Review ‘First Take:’ Déjà Vu All Over Again.”
For the past few years, low interest rates have been a key concern for plan sponsors. The declining interest rate environment and the pressure it has placed on funded levels and pension expense has highlighted, in recent years, the discount rate assumption. “That has been the biggest problem for plan sponsors in the past few years,” Moran said. The average discount rate declined about 70 basis points in 2012, placing upward pressure on gross pension obligations and pension expenses and downward pressure on funded levels, according to the white paper (see Exhibit 5 from GSAM).
Corporate defined benefit (DB) plan sponsors benefited from both rising equity prices and bond yields in early 2013, but they may be wondering whether this will continue. GSAM’s Investment Strategy Group (ISG) conducted research that suggests rising equity prices and bond yields can co-exist, at least in a low-yield environment. The white paper shows that stock prices and bond yields remain positively correlated until risk-free rates begin to compete with equity returns. That inflection point has coincided with 10-year Treasury yields of about 6% historically, suggesting rates and equities can still move higher together and continue to help improved funded levels in 2013, the white paper said.
Many clients have expressed concerns that they have wanted to implement de-risking programs over the past several years, but falling long-term interest rates have prevented it, Moran said. Although interest rates have declined over the past several years, GSAM was able to identify three periods during this multi-year decline in yields where interest rates had risen about 100 basis points or more.
For many corporate plans, such a rise in yields would have had a triggering event on their glide path. Unfortunately, these yield increases reversed rather quickly. Because of the quick reversal, plan sponsors must be nimble and prepared to take advantage of the situation when it arises, Moran said.
He suggests two things plan sponsors can do in advance of de-risking:
- Work with investment managers to change benchmarks. Plan sponsors could consider putting paperwork in place to change to long-duration benchmarks (e.g., Barclays U.S. Long Government/Credit Index). “So if you want to de-risk, that’s already in place,” Moran said.
- Outsource CIO function. Plan sponsors that are concerned they cannot be nimble enough when when equity markets and/or bond yields rise could consider outsourcing to an investment manager.
If interest rates rise and funded status improves, the industry may see an uptick in liability-driven investment (LDI) strategies, according to Bill Quinn, executive chairman of American Beacon Advisors and independent trustee for the National Railroad Retirement Investment Trust. "It’s very likely that funded status would improve as long as companies continue to make reasonable contributions,” he added.
Quinn does not, however, anticipate significant activity in pension buyouts because of the high expense. Last year brought historic pension risk transfer activity, with Verizon and The Prudential Insurance Company of America completing a partial pension buyout (see “Verizon, Prudential Complete Partial Pension Buyout”), as well as General Motors Co. transferring some of its pension risk (see “GM Transfers Some Pension Risk”).