• Retirement Plans
• Executive Compensation
• Health & Wellness
• Instant Insight
• Insight Subscription

Email Print

Pension finance update – November

Nov 05, 2009

October marked the end of a long winning streak for equity markets stretching back to March. A late-month sell-off dragged stocks lower on the month, while high-quality corporate bond yields dropped marginally, nudging pension liabilities up. Overall, liability growth through October has now matched asset growth for a traditional 60/40 portfolio (both up 11-15% on the year), so pension funded ratios should be fairly consistent with December 31, 2008 levels.

Assets

Most categories of stocks declined in value during October. Blue chips, which lagged during the recent run-up, were off a couple percent on the month, while the broader market was down more like 5%.  Year-to-date, stocks continue to post double digit returns. Technology and overseas shares have performed best, earning 20% or more.

Bonds were mixed during October. Treasury bonds continued to suffer from increasing rates, particularly at the long end of the curve, and were flat to off a couple percent on the month. High quality corporate bonds, on the other hand, rose 1% or so on the month, as the long march toward a normalization of credit spreads continued during October. Year-to-date, Treasuries have lost maybe 2% this year, though longer-dated issues are off 10% or more, while high quality corporates continue to post returns of 10% or more on the year.

Overall, the traditional 60/40 pension portfolio is likely up 11-15% on the year through October.

Liabilities

Both funding and accounting liabilities are now driven by high quality corporate bond yields. The chart below compares the J.P. Morgan Aa Yield Curve at December 31, 2008 and October 31, 2009:

Overall, rates have come down significantly at most maturities, with the most pronounced movements at the short end of the curve. We saw very little movement in the curve during October, as higher Treasury yields continue to be neutralized by tightening credit spreads. Overall, we expect discount rates for short duration plans to be about 1.00% lower than at December 31, 2008, while, for a duration 12 plan, we estimate effective rates to be perhaps 0.50% lower than what was used at the end of last year.

So, a typical pension plan has likely seen an increase in liabilities of 11-15% this year, with shorter duration plans seeing the biggest increases.

Looking ahead

With two months left in 2009, pension plans continue to tread water this year. Solid equity returns have not been able to reverse the declines in pension funded status during 2008, because pension liabilities have continued to rise on the back of lower corporate bond yields.