Interest rates can move pension funded status up or down significantly. An interest rate collar can protect funded status against a decline in rates, while rate increases can still improve funded status.
Long term interest rates saw some of the steepest rises in recent memory in early September, with the 10 year US Treasury yield rising ~30bps in a few days. This increase was not fully sustained for the rest of the month but discount rates did remain higher compared to their multi-year lows achieved in August.
On September 18th, River and Mercantile proudly joined a group of 230 institutional investors (representing $16.2 trillion in assets under management) to sign a statement urging companies to take action against the escalating crisis of deforestation in Brazil and Bolivia.
Most sponsors of corporate pension plans are familiar with their risk being asymmetric: they only benefit to a point if a plan’s funding level improves, but are on the hook for all underfunding if it does not. This recognition of asymmetry has led to a large increase in plans adopting Liability Driven Investing (LDI) frameworks.
For the fifth consecutive quarter, total pension buyout sales surpassed $4.7 billion. This is down 42% compared to Q2 2018 when FedEx completed a $6 billion transaction. However, a total of 112 buyout contracts were sold in Q2, bringing 2019 sales to 190 contracts, an increase of 32 compared to first half 2018. Total 2019 sales are estimated to surpass $25.5B, which could end up being less than the total sales from 2018.
Equity returns of 15% or higher would usually be cause for celebration among corporate pension plan investors. However, despite these strong returns, many plan sponsors have seen a decline in their funded ratios during 2019. This is mainly attributable to falling interest rates, causing the value of liabilities to increase faster than assets for many. This is a continuation of a frustrating cycle that plan sponsors are all too familiar with: strong equity returns offset by rapidly rising liability values.
On August 8th, former pension plan participants filed a lawsuit aimed at both the retirement committee of the plan sponsor, Community Health Systems, Inc., and the target date provider, Principal Global Investors, LLC, among other Principal entities. This lawsuit highlights the need for plan sponsors to review their passive index funds on a regular basis.
August proved to be a difficult month for equity markets as continuing trade tensions and weakening economic data triggered a flight to safety. As a result, interest rates fell across the curve more so at the long end which caused a portion of the yield curve to invert. Emerging market equities were hurt the most in this off-risk environment. Given the above, funded status for plans that were not hedged likely decreased significantly for the month.
PBGC premiums for 2019 are coming due soon, and there are two options to determine the interest rate used when calculating a plan’s premium based on underfunding. One option will reduce the premium this year, but at the likely cost of a higher premium next year.
Following up on what was a very positive month of June for most plans, July proved to be fairly uneventful. Modest movement in discount rates with generally small equity gains should leave most plans in more or less the same funded position at the end of the month as they were in at the end of June. Year-to-date performance should look good for most plans.