Corporate pension funding levels improve during the first quarter, coming off a difficult 4th quarter last year. The improvement was driven by strong equity market performance, and was partially offset by declining interest rates and tightening credit spreads that increased liabilities.

Review

Corporate defined benefit plans saw improvements in funding level during first-quarter 2019. A typical return-driven plan had a 2.2% increase in its funded ratio, while a typical liability-driven plan observed a 1.5% improvement. 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 markets provided the only positive impact on funded level, while interest rate declines and tightening credit spreads that increased liabilities had a negative impact.

Funded Ratio Change: Return-Driven Plan                            Funded Ratio Change: Liability-Driven Plan

Source: PNC

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 (public equity in this case) 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 14 years.

Treasury Rates

Treasury Curve

Source: BAML U.S. Treasury Curve

Treasury rates declined and lowered funded ratios as liabilities increased.

Treasury rates declined across the entire yield curve during the quarter, with the largest declines seen in the middle of the curve. The short and longer end of the curve declined 20 basis points (bps) while around the 10-year point saw declines close to 30 bps. Concerns about slowing economic growth increased the demand for safer U.S. Treasury bonds. Further, a Federal Reserve (Fed) rate hike during 2019 appears to be off the table and investors are now eying the possibility of a rate cut during the year.

Credit Spreads

Credit Spreads

Source: Barclays Live

Tightening credit spreads further lowered funded ratios as liabilities increased.

Credit spreads tightened during the quarter as investors pursued higher returns, allowing corporate bonds to post strong returns during the quarter. Intermediate and long credit spreads narrowed 33 and 28 bps, respectively. Credit outperformed Treasuries during the quarter, and the lower the credit quality, the higher the returns. On a net basis, the total corporate bond discount rate (which is derived from higher quality bonds) was down around 42 bps with 18 bps attributed to corporate spread tightening.

Equities

Equity Index Total Returns

Source: Russell, MSCI

Strong equity markets helped improve plan funding levels.

Equities posted strong gains during the quarter, rebounding from the year end pullback. This was driven by the Fed’s change in stance on rate hikes, solid earnings results, and optimism on the U.S.-China trade deal. Broad domestic and international equities posted double-digit increases during the quarter. In U.S. markets, growth stocks and mid-cap stocks produce some of the largest gains. Developed international and emerging markets had similar performance. This performance increased plan assets and resulting funding levels.

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