Pension Funded Status Sees Decline for June and Q2 2017

The aggregate funded ratio for U.S. corporate pension plans decreased by 0.4 percentage points to end the month of June at 83.1%, according to Wilshire Consulting, the institutional investment advisory and outsourced-CIO business unit of Wilshire Associates Incorporated.

The monthly change in funding resulted from a 0.7% increase in liability values, which was partially offset by a 0.2% increase in asset values. “June marked the third consecutive month of small declines in funded ratios after seven consecutive months of rising or flat funded ratios,” says Ned McGuire, vice president and a member of the Pension Risk Solutions Group of Wilshire Consulting. “June’s decrease was driven by the increase in liability values resulting from a 5 basis points fall in the corporate bond yields used to value pension liabilities. Slight positive returns for most asset classes helped to partially offset the rise in liability values.”

Mercer reports the estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 1% to 82% in June, with a decrease in discount rates partially offset by mixed equity markets. As of June 30, the estimated aggregate deficit of $416 billion represents an increase of $25 billion as compared to the deficit measured at the end of May.

The S&P 500 index gained 0.5% and the MSCI EAFE index lost 0.4% in June. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased by 4 basis points to 3.78%.

“Another Fed rate hike resulted again in a downward tick in pension discount rates,” says Matt McDaniel, a partner in Mercer’s US Wealth business. “It is yet another reminder that the long duration rates used for pension liabilities are much more sensitive to supply and demand factors than to short-term Fed policy decisions. This means that the future rate increases planned by the Fed probably won’t directly translate to improved pension funded status. Sponsors need a strategy to deal with a potentially flattening yield curve – those holding fixed income investments in a traditional aggregate strategy may find themselves hit the hardest as rates increase.”

October Three’s model Plan A, a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, lost close to 1% in June, while its model Plan B, a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation and a greater emphasis on corporate and long-duration bonds, lost a fraction last month.

However, October Three notes that both model plans it tracks have enjoyed modest improvement overall in the first half of 2017. The funded status for Plan A is up 7% for the year, while the funded status for Plan B is now almost 5% ahead during 2017.

Legal & General Investment Management America (LGIMA)’s Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical U.S. corporate defined benefit (DB) pension plan, indicates funding ratios fell over the second quarter of 2017. LGIMA estimates the average funding ratio fell from 83.9% to 82.8% over the quarter.

The Pension Fiscal Fitness Monitor showed pension assets grew less than pension liabilities. Global equity markets increased by 4.45% and the S&P 500 increased 3.09%. Plan discount rates fell 23 basis points, as Treasury rates decreased by 15 basis points and credit spreads tightened by 8 basis points. Overall liabilities for the average plan rose 4.55%, while plan assets with a traditional “60/40” asset allocation increased 3.24%, resulting in a funding ratio decrease of 1.05%.

LGIMA’s Head of Solutions Strategy, Don Andrews, says: “We estimate that funded ratio levels for the typical plan with a traditional asset allocation decreased primarily due to assets failing to keep pace with pension liabilities. While equity markets rallied, lower interest rates and tighter credit spreads resulted in an even stronger quarter for liability values, which contributed negatively to the funded ratio.”

He adds, “We are seeing continued interest from many plan sponsors looking to manage funding ratio outcomes and minimize volatility. In particular, plan sponsors are considering customized [liability-driven investment] strategies such as liability benchmarking, completion management, and option-based hedging strategies.”

The Pension Fiscal Fitness Monitor assumes a typical liability profile and 60% global equity/40% aggregate bond investment strategy, and incorporates data from LGIMA research, Bank of America Merrill Lynch and Bloomberg.