Corporate defined benefit plans saw increases in funding levels during fourth-quarter 2020, driven by a strong rally in public equity markets. A typical return-driven plan had a 6.6% increase in its funded ratio, while a typical liability-driven plan observed a 3.1% 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. For the full calendar year 2020, funded ratios for both plan types were relatively unchanged, although the paths taken were quite different.

Chart 1:  Funded Ratio Change: Return-Driven Plan

 

Source: PNC; Data as of 12/31/20

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Chart 2: Funded Ratio Change: Liability-Driven Plan


Source: PNC; Data as of 12/31/20

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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.
  • The 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 climbed higher and had a small positive impact on funded status

During the quarter, long-term Treasury yields rose, increasing approximately 15-30 basis points (bps) along the curve. The bond market continues to look forward to improved economic growth. In isolation, this increase in Treasury yield decreased the liability and improved funded ratios for pension plans.

Chart 3: Treasury Curve


Source: BAML US Treasury Curve; Data as of 12/31/20

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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 31 bps, while long spreads tightened 47 bps. Spreads tightened as investors became more optimistic, mirroring the equity market performance. Higher quality credit showed less tightening. On a net basis, considering increasing Treasury yields, the total corporate bond discount rate for pensions decreased 18 bps and increased plan liabilities.

Chart 4: Credit Spreads


Source: FactSet® Research Systems Inc;. Data as of 12/31/20

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Equities

Equity market performance had a large positive impact on funded status

Equity markets pulled back in October until the announcement of a successful COVID-19 vaccine increased investor confidence, leading to a strong rally in November and December. Returns were strong globally with international returns outpacing domestic. In the United States, small cap stocks lead the way with returns just over 14%. International developed and emerging markets returned just over 17% combined, and US equities as a whole increased approximately 14% over the quarter.

Chart 5: Equity Index Total Returns


Source: FactSet Research Systems Inc;. Data as of 12/31/20

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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 +2.5%
Change Due to Credit Spreads -5.8%
Change Due to Equities +9.9%
End of Quarter 106.6%

Chart 2: Funded Ratio Change: Liability-Driven Plan

Liability-Driven Plan Funded Ratio Change
Beginning of Quarter 100%
Change due to Treasury Rates +.7%
Change Due to Credit Spreads -1.9%
Change Due to Equities +4.3%
End of Quarter 103.1%

Chart 3: Treasury Curve

Maturity 9/30/2020 12/31/2020 Change (bps)
0
0.00% 0.00% 0
2
0.09% 0.09% 0
4
0.22% 0.27% 5
6
0.39% 0.52% 13
8
0.53% 0.73% 20
10 0.64% 0.90% 26
12
0.76% 1.04% 28
14 0.88% 1.16% 28
16 1.02% 1.28% 27
18
1.16% 1.40% 24
20 1.29% 1.50% 21
22 1.40% 1.59% 19
24 1.48% 1.66% 17
26 1.54% 1.70% 17
28 1.55% 1.73% 17
30
1.54% 1.73% 19

Chart 4: Credit Spreads

Date Intermediate Credit Option-Adjusted (OAS) Long Credit Option-Adjusted Spread (OAS)
9/30/2020 0.93
1.88
10/31/2020 0.85 1.77
11/30/2020 0.69 1.50
12/31/2020 0.62 1.41

Chart 5: Equity Index Total Returns

Index Date Percent
Russell 3000 9/30/2020 0.0
  10/31/2020 -2.16
  11/30/2020 9.74
  12/31/2020 14.68
MSCI ACWI ex USA 9/30/2020 0.0
  10/31/2020 -2.15
  11/30/2020 11.01
  12/31/2020 17.01