The second quarter wasn't kind to the funding of corporate defined benefit plans as a stagnant stock market, coupled with a continued decline in discount rates, wiped out all funded status gains made in the first quarter, according to four separate reports.
A typical corporate pension plan's funded status dropped 8% to the low 70% range from 80% to 85% at the end of the first quarter, according to Legal & General Investment Management America's quarterly report issued July 5. Global equities were down 5% for the quarter following a 12% increase in the first quarter, resulting in a 2% decrease in value for a traditional 60% equity/40% aggregate bond strategy, according to LGIMA. Meanwhile, the discount rate fell 40 basis points to 4.4%.
“The doom and gloom in Europe put a damper on equity markets,” said Andrew Carter, Chicago-based pension solutions strategist at LGIMA, in a telephone interview.
UBS Global Asset Management's quarterly report issued July 3 showed a typical U.S. corporate pension plan's funding ratio decreased five percentage points to 78% in the second quarter and was relatively flat for the year. Liabilities increased 6% for the quarter.
UBS said a typical plan's asset pool returned about -1.1% for the quarter, based on the average reported asset allocation weightings from the UBS Pension 500 database. The S&P 500 Total Return index finished the quarter down 2.8% while the MSCI EAFE index was down 7.1%.
“The first half of 2012, marked by early improvement in funded ratios followed by a sharp correction, bears a remarkable resemblance to the first half of 2011,” Francois Pellerin, head of asset liability investment solutions at UBS, said in the report. “What is also similar is the outperformance exhibited by plans whose sponsors have adopted a dynamic pension risk management framework.”
“It's a lot of the same story in some ways” compared with 2011, said Jonathan Barry, a Boston-based partner in Mercer LLC's retirement risk and finance consulting group. “The continued decline in discount rates … is putting a lot of pressure on funded status.”
According to Mercer's monthly funding report issued July 3, the aggregate funding ratio of S&P 1500 companies was 74% at the end of June, slightly below 75% at the end of 2011 and 76% at the end of May. The aggregate pension plan deficit increased $55 billion in June and was up 62% from the $336 billion at the end of the first quarter.
The funded status of a typical corporate plan actually increased to 71.6% at the end of June in BNY Mellon Asset Management's July 5 Pension Summary Report, up 1.8 percentage points from the end of May, which was the lowest funded status since the firm began tracking that data in December 2007. The funded status was 79.8% at the end of the first quarter.
U.S. equity markets increased 3.9% in June while developed international equity markets increased 7%. The market rebound from a sluggish April and May resulted in a 2.7% gain in assets while liabilities only rose 0.1%. The discount rate was unchanged at 3.98%, according to BNY Mellon.
Although equity returns were strong in June, the discount rate continued to plummet — it reached its all-time low for the Mercer report in June at 3.87%, down 28 basis points from the previous low at the end of May. The drop was compounded by the June 21 downgrade by Moody's Investors Service of 15 major banks, with a number of them losing their AA credit ratings, excluding them from yield curves used to set discount rates.
“It was a pretty big deal and dropped the discount rate about 25 to 30 basis points,” Mercer's Mr. Barry said. “As long as there is unrest and uncertainty in Europe, you are going to continue to see lower interest rates,” he said.
Mr. Barry thinks this year is seeing the start of a trend to offer lump-sum payouts to terminated vested employees and he expects to see a lot more action on that front next year. But he is still concerned that some plans do not have a long-term structure in place to deal with market volatility and ballooning liabilities.
“Not enough sponsors have a detailed strategy to react quickly as these markets change,” Mr. Barry said.
Corporate plans did see some cost relief with Congress' approval of legislation that reduces pension funding requirements by allowing a 25-year average of interest rates used to determine liabilities in the calculation of contributions. Mr. Barry said the legislation could result in up to $50 billion in relief for S&P 1500 plan sponsors for 2012 and could total more than $100 billion through 2014.
However, Mr. Barry is concerned that the “temporary relief” will further deteriorate the funded status of corporate plans. He recommends that corporations should continue making the same pension contributions as the old rules dictated if they have the cash.
The estimated aggregate value of pension plan assets of the S&P 1500 companies at the end of June was $1.55 trillion, up from $1.52 trillion in May, according to Mercer. The aggregate liabilities reached a record high of $2.09 trillion, up from $2.01 trillion in May.
Legal & General's Mr. Carter said plan executives continue to show increased interest in derisking strategies and long-term strategic plans, and some have started putting those plans into action. While the low-interest-rate environment makes it difficult to implement liability-driven investing strategies, plan executives are looking at derisking glidepaths, strategies to help hedge interest rates and options-based strategies, he added.
“Plans are thinking outside the box more,” Mr. Carter said. “People are trying to be more clever.”