Review

Corporate defined benefit plans had sizeable improvements in funding level during fourth-quarter 2019. A typical return-driven plan had a 5.9% increase in its funded ratio, while a typical liability-driven plan posted a 2.5% 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 growth accounted for the majority of the impact, while interest rate and credit spreads had minimal combined effect. With volatility during 2019, the average plan ended the year flat to slightly ahead of the end of the year-earlier funding level.

Assumptions

  • The funded ratio changes displayed above are for generic plans with 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 (in this case, public equity) and typically has high funded status volatility. Assumed asset allocation is 70% MSCI All Country World, 30% Barclays Aggregate.
  • 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 Long Credit, 14% Barclays Long Government.
  • Liability profile is based on BAML Mature/Average US Pension Plan AAA-A Corp Indexes with average duration of 15 years.

Funded Ratio Change: Return-Driven Plan


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Source: PNC

Funded Ratio Change: Liability-Driven Plan

 

 

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Source: PNC
 

Treasury Rates

Treasury Rates Increased and Improved Funded Ratios as Liabilities Decreased

Treasury rates increased along almost the entire yield curve during the quarter. The long end of the curve increased between 20 and 30 basis points (bps), while shorter maturities had smaller increases. The shortest maturities declined up to 17 bps, driven in large part by the dovish outlook for the Federal Reserve (Fed). The increases on the longer end of the curve were largely affected by progress announcements of a trade deal with China and strong economic reports.

Treasury Curve

 

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Source: BAML US Treasury Curve

Credit Spreads

Credit Spreads Decreased and Reduced Funded Ratios as Liabilities Increased

Credit spreads had a negative impact on funded ratios during the quarter. Intermediate spreads tightened 15 bps and long spreads tightened 28 bps. The trade deal progress with China, updates to the United States-Mexico- Canada Agreement, and recent political changes in the United Kingdom were large contributors to investors seeing reduced geopolitical risk. On a net basis, the total corporate bond discount rate (which is derived from higher quality corporate bonds) increased 3 bps, with the increase in Treasury rates mostly offset by spread tightening.

Credit Spreads

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Source: Barclays Live

Equities

Equity Market Performance Had a Large Positive Impact on Funded Status

Equity markets ended the year on a strong note, with global returns approximately 9% during the quarter and almost 30% for the year. Both US and international stocks steadily increased during the quarter and exhibited similar returns. With continued strong economic results, many investors are viewing a near-term global recession as less likely. In addition, some of the concerns that produced recent periods of negative market volatility have been muted, given the progress with trade deals.

Equity Index Total Returns

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Source: Russell, MSCI

For more information, contact Kimberlene Matthews, Director of Pension Solutions, at 312-338-8138 or kimberlene.matthews@pnc.com.

 

TEXT VERSION OF CHARTS

Funded Ratio Change: Return-Driven Plan

Return-Driven Plan Funded Ratio Change
Beginning of quarter 100%
Change Due to Treasury Rates 3.1%
Change Due to Credit Spreads -3.4%
Change Due to Equities 6.2%
End of Quarter 105.9%


Funded Ratio Change: Liability-Driven Plan

Liability-Driven Plan Funded Ratio Change
Beginning of Quarter    100%
Change Due to Treasury Rates 0.9%
Change Due to Credit Spreads -1.1%
Change Due to Equities 2.7%
End of Quarter 102.5%


Treasury Curve

Maturity 6/30/19 9/30/19 Change (basis points)
1 1.82% 1.65% -17
3 1.57% 1.60% 3
5
1.59% 1.72% 13
7 1.63% 1.82% 20
9 1.65% 1.89% 25
11 1.68% 1.95% 28
13 1.72% 2.02% 30
15 1.80% 2.11% 31
17 1.89% 2.21% 32
19 1.99%
2.30% 31
21 2.08% 2.39% 31
23 2.15% 2.45% 29
25
2.20% 2.48% 28
27
2.22% 2.48% 26
29 2.20% 2.45% 25
30 2.18% 2.42% 24


Credit Spreads

Date Intermediate Credit Option-Adjusted Spread (OAS) Long Credit Option-Adjusted Spread (OAS)
9/30/19 0.79 1.67
10/31/19 0.77 1.61
11/30/19 0.72 1.54
12/31/19 0.64 1.39


Equity Index Total Returns

Index Date Percent
Russell 3000 9/30/19 0.00%
  10/31/19 2.51%
  11/30/19 6.04%
  12/31/19 9.10%
MSCI ACWI Ex-US 9/30/19 0.00%
  10/31/19 3.49%
  11/30/19 4.40%
  12/31/19 8.92%