SEI Puts Out Latest Discount Rate, ROA Guidance

An SEI booklet about its latest research for 2009 plan disclosures said the prediction for year-end plans assumes no major economic upheaval during December 2009.  

Author Jon Waite said plan sponsors should consider selecting the discount rate using a method that matches plan cash flows to the yield curve between AA and AAA-rated long-term corporate bonds, rather than using an index benchmark. The yield curve as of November 30, 2009, has decreased relative to last year for durations up to 25 years, Waite pointed out.

Since the AA rated bonds provide the yields on the high end of the range, they have traditionally been the benchmark rate of choice for plan sponsors, according to Waite.

When to Decide

Plan sponsors with calendar fiscal years will typically need to wait until year end before they can finalize their discount rates. Plans with a fiscal year end of November 30 have enough information now to determine the discount rates for the 2009 disclosure.

According to SEI data, 90% of companies with defined benefit plans in the 2008 SEI Plan Sponsor Accounting Database (713 sponsors) set their discount rates in their 2008 pension disclosure between 5.50% and 6.91% — very similar to that found in the SEI prior analysis.

The 141-basis-point range of discount rates suggests diversity among companies in measurement date, fiscal year, country of origin of the pension plan, liability structure, investment philosophy and willingness to be aggressive when setting rates, SEI said. The most common range of rates from the 2008 disclosure was between 6% and 6.41%.

SEI said 57% of the plans studied increased their discount rates between the 2007 and 2008 disclosures, 23% cut the rates, and 20% made no change.

Asset Returns

Turning to a return on asset figure, Waite said that while recent market experience is a consideration in selecting an ROA assumption, plan sponsors should consider what they expect the portfolio to return over the long term. They should look at long-term capital market assumptions as a guide but customize them for their portfolios’ asset allocations.

Of the 695 plan sponsors reporting ROA assumptions, most (64%) had ROAs between 7.50% and 8.50%, a larger range (at the low end) relative to the analysis of 2007. Almost all (90%) of the plan sponsors had ROAs between 6% and 8.90%, also a slight increase (of 10 bps) in range and a lowering of the range by 10 bps versus a year earlier.

Funding Importance

Finally, SEI said sponsors have definitely taken notice of the pressures on the success of their plans by the ongoing financial turmoil with a greater emphasis being placed on funding status.

In a recent SEI poll of pension sponsors, 42% said the success metric for pension investments was “improved funded status” versus only 15% that said it was “absolute return of the portfolio.” Two years ago, 28% said it was absolute return and only 23% said it was improved funded status.

“The end result is a paradigm shift in the way pensions are being managed,” Waite commented. “The focus moving forward is on implementing a risk management process to better deal with the impact that poor investment conditions and subsequent pension funding shortfalls can have on the sponsor’s overall finances. This new focus involves a greater emphasis on funding policies and strategies, plan design considerations, and aligning investment decisions with corporate goals.”

At the end of each fiscal year, plan sponsors are required to select a discount rate based on current market conditions to be used in valuing their plan's accounting liabilities that must be disclosed in the footnotes to their financial statements. The discount rate selected for the 2008 disclosure is the same rate that will be used in the calculation of 2009 pension expense.

A copy of SEI's research is available by emailing seiresearch@seic.com.