Corporate funding rises in 1st quarter

The first quarter of 2013 ended with the funded status of U.S. corporate defined benefit pension plans having improved significantly from the end of the year, thanks primarily to strong equity returns and higher discount rates, according to several reports.

BNY Mellon Investment Management, Mercer, Legal & General Investment Management and UBS Global Asset Management all place the funded status of the typical U.S. corporate defined benefit pension plan around 82% as of March 31, up about five percentage points from the end of the year.

According to a monthly study from BNY Mellon Investment Management, the funded status of the typical U.S. corporate defined benefit pension plan rose 1.9 percentage points to 82.6% in March. The report credited the increase to healthy equity returns, while Aa corporate spreads increased by two basis points, raising the Aa corporate discount rate to 4.09%. The funding ratio of a typical plan at the end of 2012 was 76.3%.

Jeffrey B. Saef, New York-based managing director and head of the investment strategy and solutions group at BNY Mellon, said in a telephone interview that the numbers for the first three months of the year make some sense.

“It's like a puzzle. The various pieces work together,” Mr. Saef said. While in the summer of 2012, equity markets dropped, rates dropped and spreads dropped, “now we're seeing just the exact opposite. Equity markets are rallying, rates are rising, spreads are rising.”

In contrast to the strong first quarters evidenced in the last couple of years that were followed by drops in the second and third quarters in those years, Mr. Saef said the global macroeconomic tone is better now with strong housing, auto, durables and employment sectors.

“The tone is certainly better,” Mr. Saef said. “Looking forward on (first-quarter) earnings, you'd hope that would continue along with stable and rising rates.”

Mercer's monthly study of S&P 1500 companies reflected similar gains. The aggregate funding ratio of S&P 1500 companies rose to 82% at the end of March, up from 77% at the end of February, primarily because of the 3.75% increase in the markets. High-quality corporate bond rates that affect liabilities rose only slightly to 3.86% at the end of March from 3.82% at the end of February. The aggregate funding ratio of S&P 1500 companies was 74% at the end of 2012.

“Certainly, the funded status improvement we saw in the first quarter is a great outcome for most plan sponsors” said Jonathan Barry, a partner in Mercer's retirement business, in a news release. “However, there is still some heavy lifting for plan sponsors to do to get to a fully funded position. Also, we saw a similar pattern in 2011 and 2012, where funded status improved significantly in the first quarter, only to see those gains reverse themselves as the year went on.”

According to Legal & General Investment Management's quarterly Pension Fiscal Fitness Monitor, which incorporates data from LGIMA research, Bank of America Merrill Lynch and Bloomberg, the typical U.S. corporate defined benefit plan's funding ratio rose to about 83% in the first quarter, from about 76% at the start of the year.

The funded status of a corporate plan with a traditional 60% global equity/40% aggregate fixed-income strategy increased about 6.5 percentage points. Global equities were up about 6.5%, while discount rates were up 32 basis points.

Treasury rates and credit spreads rose 21 and 11 basis points, respectively, in the first quarter, leading to the significant rise in discount rates over the quarter.

“It really was the perfect storm,” said Gary Veerman, Chicago-based head of LDI strategy at LGIMA, in a telephone interview.

Mr. Veerman did say that political uncertainty, notably in Cyprus and the Korean peninsula, could lead to “systemic shocks to the market” that could stem those gains.

Meanwhile, UBS Global Asset Management's quarterly UBS Pension Fund Fitness Tracker, which uses data from 500 U.S. corporations' defined benefit plans, said that the typical U.S. corporate defined benefit pension plan's funded status improved to 82% in the first quarter. The typical plan's funding ratio at the end of 2012 was 77%, according to UBS.

A typical plan's portfolio returned 4.7% during the quarter, while the discount rate increased 10 to 15 basis points, resulting in a 1.6% decrease in liabilities.

Despite the gains of the first quarter, a report from Wilshire Associates warns the vast majority of U.S. corporate defined benefit pension plans are still underfunded.

While the report does not include the first quarter's gains, it does warn that despite the equity gains of 2012, low interest rates are still the largest issue facing corporate pension funding.

Of the 308 companies in the S&P 500 that maintain defined benefit pension plans, 94% had underfunded plans in 2012, the same amount as the previous year, according to the 2013 Wilshire Consulting Report on Corporate Pension Funding Levels. The median funding ratio was 76.9%, down from 78.1% in 2011.

The drop in median funding ratio despite a median 11.8% rate of return for 2012, up from 3.8% in 2011, was due to a drop in the median discount rate to 4.16% in 2012 from 5%.

Combined assets of the corporate pension plans increased to $1.2209 trillion in 2012 from $1.1075 trillion the year before, but liabilities increased to $1.564 trillion at the end of 2012 from $1.3898 trillion the previous year.

“The main thing that you know, the one notable tidbit that one can get out of this despite how strong the equity markets were, (is) we are now dealing with market conditions related to fixed income that are impacting pension funding in maybe a slightly unanticipated way, even though the reasons for what are going on are obvious,” said Russ Walker, Santa Monica, Calif.-based vice president at Wilshire Associates, and co-author of the report, in a telephone interview, “and you can connect the dots between (Pension Protection Act) rules affecting how discount rates are calculated and how that percolates down to our current situations in which interest rates are pretty much artificially held low.”

“These discount rates are so low the liabilities are ballooning,” Mr. Walker said. “They're kind of swamping the great gains the assets have actually enjoyed for the year. You've got accounting rules impacting this very important measure of funding health for pension plans.”

The highway bill, signed by President Barack Obama on July 6, which changed some pension funding requirements, did help keep funding ratios from getting too low.

“I think without that, contributions might have to have been quite a bit higher than they were, and potentially we'd have some funding ratios which are lower than they are,” Mr. Walker said. n

Reporters Rick Baert and Kevin Olsen contributed to this story.