U.S. Pension Funding Ratios Decline Sharply During Third Quarter

François Pellerin, Head of Asset Liability Investment Solutions, commented, “Market environments where funded ratios are dreadfully impacted by a collapse of equity markets and a rally in interest rates seem to occur much more often than expected. This outlines the importance of a sound pension risk management framework.”

The drop in funding ratio was primarily driven by two factors:

•  Increased liability values resulted from a strong rally in U.S. Treasury yields. The decrease in yields was partially offset by a large widening of credit spreads. On a net basis, yield declines outpaced widening spreads, leading to significantly lower corporate bond yield curve and pension discount rate. For the quarter, it is estimated that pension discount rates fell by approximately 85 basis points, resulting in an estimated 10% increase in pension obligations.

•  Performance was negative across most asset classes, with a slight increase in fixed income assets marginally offsetting sizable losses in equity assets, leading to negative returns of approximately -7% on a typical pension plan’s assets. 


For the third quarter, a typical pension plan’s assets returned approximately -6.8%, based on the average corporate plan's reported asset allocation weightings from the UBS Global Asset Management Pension 500 Database and publicly available benchmark information. Risky asset markets weakened considerably throughout the entire quarter, each month produced negative returns across most risky asset classes. The overarching themes that led to such poor performance stemmed from continued uneasiness over the health of multiple European sovereigns and growing worries of an economic slowdown, led by concerns over the health of the U.S. economy. Additionally, renewed concerns over the funding levels of many European banks, as well as a downgrade in the credit quality of long-term U.S. debt, accelerated negative performance over the quarter. The S&P 500 Total Return Index finished the quarter down approximately 13.9%, outperforming other developed markets, with the MSCI EAFE index finishing down approximately 19%.

Bond markets generally rallied throughout the third quarter, as increasing concerns in global macroeconomic conditions and select sovereign debt drove increasing demand for fixed income placing downward pressure on bond yields. Reflecting concerns over the U.S. economy, corporate bond spreads widened considerably over the quarter. However, widening spreads were more than offset by the decline in interest rates, leading to an impressive rally in corporate debt over the quarter. The 10-year U.S. Treasury yield decreased by 123 basis points, finishing the quarter at 1.93% as compared to the June 30 yield of 3.16%. The 30-year U.S. Treasury yield decreased by 146 basis points, finishing the quarter at 2.92% as compared to the June 30th yield of 4.38%. High-quality corporate bond credit spreads, as measured by the Barclays Capital Long Credit A+ option-adjusted spread, ended the quarter approximately 63 basis points wider. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) decreased by roughly 80 to 90 basis points during the quarter. For the quarter, liabilities for a typical pension plan increased by approximately 10%.