Corporate Bond Yields Have a Positive Effect on Pension Funding in September

The estimated aggregate funding level of defined benefit (DB) plans sponsored by Standard &Poor’s (S&P) 1500 companies increased by 1% to 83% funded status in September, as a result of an increase in discount rates and supported by positive equity markets, according to Mercer.

 

As of September 30, the estimated aggregate deficit of $392 billion represents a decrease of $40 billion as compared with the deficit measured at the end of August. The aggregate deficit is down $16 billion from the $408 billion measured at the end of 2016.

 

The S&P 500 Index gained 1.93%, and the MSCI EAFE Index gained 2.23% in September. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased by 7 basis points (bps) to 3.71%.

 

“Interest rates finally moved in a positive direction while equities rose,” says Matt McDaniel, a partner in Mercer’s wealth business. “With both these forces working together, pension funded status is now the highest it has been since fall 2015. Now, the ball is in plan sponsors’ court to make sure they preserve these gains. Plans using a dynamic de-risking strategy should be frequently monitoring funded status to see if triggers are hit, and those considering risk transfer transactions may find that the time is right.”

 

According to Northern Trust Asset Management, during September, pension plans generally experienced a healthy improvement, as average funded ratios increased from 81.7% to 82.9%.

 

This growth was driven by two primary factors:

• Asset returns were strong, as global equity markets returned nearly 2%, and
• The average discount rate increased modestly, from 3.65% to 3.72%—higher discount rates lead to lower liabilities.

The average funded ratio improved from 80.0% at the beginning of year to 82.9% at the end of last month, as broadly positive asset returns have more than compensated for the decline in discount rate.

 

Northern Trust notes that, currently, there is considerable discussion in Washington regarding reducing the corporate tax rate. If lawmakers can get a deal done, the firm expects to see corporations accelerate contributions to take advantage of a greater tax deduction before rates change. Increased contributions would be beneficial to pension plan funded ratios and could lead to further de-risking of plans.

 

October Three says pensions enjoyed their best month of the year in September, resulting from strong stock markets and rising interest rates. Both of the model plans it tracks saw improvements last month: Traditional Plan A improved more than 2% and is now up more than 3% for the year, while the more conservative Plan B gained close to 1% and is now ahead more than 1% through the first three quarters.

 

Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation emphasizing corporate and long-duration bonds. Overall, the traditional 60/40 portfolio gained more than 1% in September and is now up 10% for the year, while the conservative 20/80 portfolio lost less than 1% last month but is still up more than 6% for the year.

 

Stocks enjoyed another strong month in September while corporate bond yields moved up 0.15%, ending a five-month streak of lower rates and providing relief to pension sponsors. The move pushed pension liabilities down 1% to 2% in September.

 

The aggregate funded ratio for U.S. corporate pension plans increased by 1.3 percentage points to end the month at 84.7%, up 7.9 percentage points over the trailing 12 months, according to Wilshire Consulting.

 

The aggregate figures represent an estimate of the combined assets and liabilities of corporate pension plans sponsored by S&P 500 companies with a duration in line with the Citi Group Pension Liability Index – Intermediate.

 

The monthly change in funding resulted from a 0.9% decrease in liability values combined with a 0.5% increase in asset values. The aggregate funded ratio was up 1.4 percentage points for the third quarter and 2.8 percentage points year to date.