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PrintSep 14, 2009
The equity markets continue to rebound and corporate bond yields continue to decrease, resulting in a deterioration in pension funded status during the month. But overall, a typical defined benefit plan has still seen an improvement in funded status year-to-date of 2-5%.
August marked a continuation of the trend we've seen this year since early March – stocks up, interest rates down. The net effect is a modest deterioration in pension funded status during the month, but overall, plans continue to enjoy a slight improvement in funded status during 2009 of 2-5%, although underfunded plans may be closer to break-even on the year, since a smaller asset base requires a greater percentage asset return to neutralize a drop in interest rates.
Assets
August saw continued strong performance across the spectrum of equity investments, which all gained 3-6% on the month and are all up double-digits (more for small-cap, technology, and international stocks) this year.
Bonds added 1-4% during August, with corporate issues and longer maturities doing best, reflecting declines in interest rates and modest tightening of credit spreads during the month. For the year, corporate bonds have likely produced yields of 10% or more, while Treasuries remain mostly in the red.
Overall, the traditional 60/40 pension portfolio is likely up 10-14% on the year through August.
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 August 31, 2009:
The pattern is similar to what we saw at the end of July – significant drops at shorter maturities and modest increases in yields at very long maturities. Overall, discount rates for short duration plans may be 0.75% lower than at 12/31/2008, while, for a duration 12 plan, we estimate effective rates to be about 0.25% lower than what was used at 12/31/2008.
So, a typical pension plan has likely seen an increase in liabilities of 7-10% this year, with shorter duration plans seeing the biggest increases.
We expect plans with an August 31 measurement would generally use FAS 87 discount rates in the range of 6.00%-6.50%. The "spot" curve under PPA, however, is registering larger declines in rates this year and is currently producing effective rates under 6%. If this trend holds, using spot rates for 2010 valuations will produce liabilities 10% higher than those obtained using 24-month smoothed rates.
Looking ahead
Through eight months, pension plans have weathered 2009 with modest improvements in funded status. A typical 60/40 portfolio has tracked liability changes remarkably well this year, with negative asset returns early in the year offset by rising interest rates, and the reverse over the past several months, with healthy asset returns negated by declining interest rates.
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