Reports Reveal Hard Times for Corporate Pensions

(October 6, 2011) — Corporate defined benefit plans in the United States are suffering declining funding levels as they continue to be pummeled by low interest rates and a consequential rise in liabilities.

Legal & General Investment Management America (LGIMA), BNY Mellon Asset Management, and UBS Global Asset Management have all separately released reports showing that corporate funding is on the decline, with schemes hit by falling equity values.

LGIMA announced in its Pension Fiscal Fitness Monitor, a quarterly estimate of the change in health of a typical US corporate defined benefit pension plan, that pension funding ratios fell approximately 22% in the third quarter of 2011. During the last two quarters funding ratios have dropped nearly 24%. According to the firm, the average funding ratio will likely be in the range of 70-75% as of the end of the third quarter, approximately down 18% year-to-date.

“Plans using a traditional ’60/40′ investment strategy suffered the second largest quarterly funding ratio drawdown in the past 20 years,” LGIMA’s Head of US Pension Solutions, Aaron Meder said in a statement. “This likely represents more funding risk within their plans than they would have anticipated. As a result, we see the plan sponsor community taking a step back and evaluating when, not if, they will take some risk off the table.”

Meder added: “Even in today’s challenging interest rate and funded status environment we still see our clients taking steps to more effectively manage funding ratio outcomes. For example, we have seen a pick-up in less traditional implementation alternatives. In particular, interest rate option strategies are currently priced at historically attractive levels and allow plans to benefit significantly from rising interest rates while offering valuable funded status protection against further interest rate declines. Going forward, I would expect this trend to continue as corporations look to get back to their core businesses and make pension risk management a priority.”

Additionally, a new report by BNY Mellon Asset Management has shown that the funded status of the typical US corporate plan declined 7.9% in September to 70.1%. The firm showed that assets dropped 4.5% due to falling equities, while liabilities increased 6.2% because of a 40-basis-point drop in Aa corporate discount rates.

A new report by UBS Global Asset Management contributed to the news of dismal funding for corporate pension funds, showing a 13% decline in funding ratio for the typical DB plan in the third quarter. During the same period, corporate discount rates dropped about 85 basis points while increasing pension obligations by 10%.

The environment of low interest rates and declining equity markets have spurred questions over how this will impact corporate funds eying and pursuing a liability-driven investment strategy.

“Plan sponsors have been reluctant to go into LDI for years, yet there’s plenty of room for everyone in LDI strategies,” Scott Whalen, senior consultant at Seattle-based Wurts & Associates, told aiCIO in late September following the Federal Reserve’s move to buy long-term treasuries. “Very few investors expected interest rates to go this low, and fewer still expect them to go much lower from here,” he said, noting that corporate pension funds have historically decided to pursue LDI because it was more important for them to stabilize their plan’s funded status and its impact on financial statements and decrease the volatility of their portfolios than it was to increase the value of their assets. “People who went into LDI didn’t expect interest rates to drop, so they got the added bonus of assets increasing, unexpectedly.”