Lower Interest Rates Continue to Plague DB Plan Funded Status

Defined benefit (DB) plan funding ratios decreased throughout the month of July, primarily driven by tightening credit spreads, resulting in a decrease in the discount rate, according to Legal & General Investment Management America (LGIMA). It estimates that the average plan’s funding ratio fell 0.8% to 82.3% through July.

LGIMA’s Pension Solutions’ Monitor report notes that, “The rates market once again took its cues from the central bank. Echoing sentiments other members had voiced in June speeches, Fed Chair Powell’s comments before Congress at the Humphrey Hawkins meeting emphasized concerns over trade issues, slowing global growth, and inflation trending below target. This testimony, coupled with the release of the June FOMC minutes, set the groundwork for the first Fed cut since the financial crisis. At the July 31 meeting, the Fed cut interest rates by 25 basis points and ended their balance sheet runoff two months earlier than planned.”

LGIMA estimates the discount rate’s Treasury component increased by 1 basis point while the credit component tightened 7 basis points, resulting in a net decrease of 6 basis points. The negative impact due to the change in Treasury rates is a function of positive carry of the liabilities. Overall, liabilities for the average plan increased 1.21%, while plan assets with a traditional “60/40” asset allocation increased by approximately 0.28%.

Due to lower interest rates, liability values increased, and were only partially offset by muted asset performance, according to Ned McGuire, managing director and a member of the Investment Management & Research Group of Wilshire Consulting. According to the firm, the aggregate funded ratio for U.S. corporate pension plans decreased by 0.4 percentage points to end the month of July at 85.6%. It says liability values increased 0.7% for the month, while asset values increased 0.3%.

Northern Trust Asset Management (NTAM) also says positive returns in the equity market were not enough to offset higher liabilities which led to lower funded ratios. It estimates the average funded ratio for S&P 500 DB plans slipped in July from 86.5% to 86%. NTAM says global equity market returns were up approximately 0.3% during the month. The average discount rate decreased from 3.06% to 2.99%, leading to higher liabilities.

According to Mercer, the estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 1% in July to 86%, as a result of a decrease in discount rates. As of July 31, the estimated aggregate deficit of $322 billion increased by $14 billion as compared to $308 billion measured at the end of June. The S&P 500 index increased 1.44% and the MSCI EAFE index decreased 1.26% in July. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased from 3.44% to 3.38%.

“Plan sponsors should review their risk management toolkit to consider whether their investment policy is aligned with the current market environment and to explore potential risk transfer activity, such as a lump sum window, which may be attractive to pursue before the end of the year,” said Scott Jarboe, a partner in Mercer’s Wealth Business.

However, River & Mercantile’s “Retirement Update – August 2019” calls July “uneventful.” “Modest movement in discount rates with generally small equity gains should leave most plans in more or less the same funded position at the end of the month as they were in at the end of June,” it says.

October Three reports pension finances dipped slightly in July as long-term corporate bond yields hit record lows. Both model plans it tracks lost a fraction of 1% in July and are basically treading water (Plan A down 1%, Plan B flat) through the first seven months of 2019. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

Brian Donohue, partner at October Three Consulting, says, “Discount rates fell a few basis points last month and have now reached the lowest yields on record. We expect most pension sponsors will use effective discount rates in the 3.2% to 3.7% range to measure pension liabilities right now.” He also notes that, “Pension funding relief has reduced required plan funding since 2012, but under current law, this relief will gradually sunset by 2023, increasing funding requirements for pension sponsors that have only made required contributions.”

Aon’s Pension Risk Tracker shows the S&P 500 aggregate pension funded status decreased slightly in July, from 86.8% to 86.6%. Pension asset returns were positive in July, ending the month with a 0.6% return. The month-end 10-year Treasury rate increased by 2 basis points (bps) relative to the June month-end rate, and credit spreads narrowed by 7 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 3.20% to 3.15%.