PensionsFebruary 13, 2020

Tumbling Discount Rates Eat Away at Funded Ratios

Despite $14 billion investment gain in January, falling rates cause US corporate pension deficits to balloon.

Reported by Michael Katz

A sharp drop in the discount rate in January has caused the funding deficit of the 100 largest corporate pension plans in the US to balloon by $73 billion, reducing the funded ratio for the plans to 85.7% from 89.0% for the month.

The funding decline is the result of a 35 basis point drop in the monthly discount rate, which fell to 2.85% from 3.20% in December, according to consulting firm Milliman, which tracks the plans through its Pension Funding Index (PFI)

The firm said it was the lowest rate recorded in the 20-year history of the PFI, and only the second time the PFI’s monthly discount rate has fallen below 3%. As a result, pension liabilities increased $87 billion in January, despite strong investment gains of $14 billion during the month. The investment gains increased the market value of the plans’ assets to $1.633 trillion at the end of January. However, at the same time, the projected benefit obligation (PBO), or pension liabilities, increased to $1.906 trillion at the end of January.

“Corporate pensions are now starting off the year trying to dig their way out of a hole created by January’s steep discount rate drop,” Zorast Wadia, author of the Milliman 100 PFI, said in a statement. “While much of the funding improvement from the fourth quarter of 2019 has been wiped out, there’s a silver lining in the strong investment returns experienced this month. Let’s hope that continues, with discount rates rising above 3% again.”

Despite a 13% cumulative asset return for the pensions over the past 12 months, the Milliman 100 PFI funded status deficit has declined by $124 billion, and the discount rate has fallen 121 basis points to 2.85% as of Jan. 31 from 4.06% over a year ago.

Milliman said that under an optimistic forecast, which has interest rates rising to 3.40% by the end of 2020 and 4.00% by the end of 2021, combined with annual asset gains of 10.6%, the funded ratio of the plans would climb to 99% by the end of 2020 and 116% by the end of 2021. However, under a pessimistic forecast in which the discount rate falls to 2.30% by the end of 2020 and 1.70% by the end of 2021, combined with annual returns of only 2.6%, the funded ratio would decline to 80% by the end of 2020 and 73% by the end of 2021.