Corporate defined benefit plans saw increases in funding levels during third-quarter 2020, driven by a strong rally in public equity markets. A typical return-driven plan had a 3.0% increase in its funded ratio, while a typical liability-driven plan observed a 1.4% increase. Liability-driven plans with higher allocations to longer duration assets tend to see smaller funded ratio movements when market volatility increases. According to our analysis, equity market expansion accounted for the majority of the impact, while credit spread tightening partially offset gains from equities.

Chart 1:  Funded Ratio Change: Return-Driven Plan


Source: PNC; Data as of 9/30/20

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Chart 2: Funded Ratio Change: Liability-Driven Plan


Source: PNC; Data as of 9/30/20

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Assumptions

  • The funded ratio changes displayed above are for generic plans with the allocation and liability profiles specified below. Results are market driven and do not incorporate any plan-specific effects, such as benefit payments, expenses, benefit accruals, or plan contributions. Funded ratio changes are sensitive to the beginning of the period-funded ratio.
  •  A return-driven plan is a pension plan with an asset allocation commonly associated with an absolute-return objective and has a high allocation to return-seeking assets (public equity in this case) and typically has high funded status volatility. Assumed asset allocation is 70% MSCI All Country World and 30% Bloomberg Barclays US Aggregate Bond Index.
  • A liability-driven plan is one that is well along its path in a liability-centric approach to investing and has a large allocation to long-duration bonds to help reduce funded status volatility. Assumed asset allocation is 30% MSCI All Country World, 56% Barclays Capital U.S. Long Credit Index, and 14% Barclays Capital Long Government Index.
  • Liability profile is based on BAML Mature/Average US Pension Plan AAA-A Corp Indexes with average duration of 16 years.

Treasury Rates

Treasury rates did not significantly change and had minimal funded ratio impact

During the quarter, the Treasury curve did not significantly change. Rates decreased slightly along the short end and increased along the middle of the yield curve. Allocations to long duration Treasury instruments may have offset funded ratio improvements. The Federal Reserve (Fed) announced a significant shift in policy to average inflation targeting with the key implication that Fed rate hikes are less likely, which may keep short rates low.

Chart 3: Treasury Curve


Source: BAML US Treasury Curve; Data as of 9/30/20

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Credit Spreads

Credit spreads tightened and lowered funded ratios as liabilities increased

Tightening credit spreads had a negative impact on funded ratios during the quarter. Intermediate credit spreads tightened 16 basis points (bps), while long spreads tightened 14 bps. Spreads tightened as investors became more optimistic, mirroring the equity market performance. Higher quality credit showed less tightening. On a net basis, the total corporate bond discount rate for pension liabilities (which is derived from higher quality corporate bonds) decreased 6 bps.

Chart 4: Credit Spreads


Source: FactSet® Research Systems Inc;. Data as of 9/30/20

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Equities

Equity market performance had a large positive impact on funded status

Equity markets continued to rally in July and August after their strong second-quarter performance and pulled back in September. Returns were strong globally with domestic returns outpacing international. In the United States, large cap growth stocks continued to lead the way with returns just over 13%. Internationally, emerging markets (EM) and Asia were the top performing segments. EM returned nearly 10%, and US equities as a whole increased almost 9% over the quarter.

Chart 5: Equity Index Total Returns


Source: FactSet Research Systems Inc;. Data as of 9/30/20

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For more information, contact Kimberlene Matthews, Director of Pension Solutions, at kimberlene.matthews@pnc.com.


Accessible Version of Charts

Chart 1: Funded Ratio Change: Return-Driven Plan

Return-Driven Plan Funded Ratio Change
Beginning of Quarter 100%
Change due to Treasury Rates 0.20%
Change Due to Credit Spreads -1.70%
Change Due to Equities 4.50%
End of Quarter 103.00%

Chart 2: Funded Ratio Change: Liability-Driven Plan

Liability-Driven Plan Funded Ratio Change
Beginning of Quarter 100%
Change due to Treasury Rates -0.10%
Change Due to Credit Spreads -0.40%
Change Due to Equities 1.90%
End of Quarter 101.40%

Chart 3: Treasury Curve

Maturity 6/30/2020 9/30/2020 Change (bps)
1 0.19% 0.14% -5
3 0.15% 0.14% -1
5 0.34% 0.31% -3
7 0.49% 0.47% -2
9 0.57% 0.59% 2
11 0.65% 0.70% 5
13 0.75% 0.82% 7
15 0.88% 0.95% 7
17 1.04% 1.09% 5
19 1.20% 1.23% 2
21 1.35% 1.35% 0
23 1.46% 1.45% -2
25 1.53% 1.51% -1
27 1.54% 1.55% 1
29 1.51% 1.55% 4

Chart 4: Credit Spreads

Date Intermediate Credit Option-Adjusted (OAS) Long Credit Option-Adjusted Spread (OAS)
6/30/2020 1.09 2.02
7/31/2020 0.92 1.83
8/31/2020 0.87 1.83
9/30/2020 0.93 1.88

Chart 5: Equity Index Total Returns

Index Date Percent
Russell 3000 6/30/2020 0.0
  7/31/2020 5.68
  8/31/2020 13.33
  9/30/2020 9.21
MSCI ACWI ex USA 6/30/2020 0.0
  7/31/2020 1.18
  8/31/2020 4.46
  9/30/2020 2.87