DB plan liabilities continue to outpace assets

Modestly higher equity markets in the first quarter of 2015 were not enough to offset the effects of lower interest rates, resulting in lower pension funding ratios among U.S. defined benefit plans.

Funding ratios fell slightly in the first quarter of 2015 as liabilities outpaced assets, according to Chicago-based Legal & General Investment Management America, Inc.

In its Pension Fiscal Fitness Monitor, LGIMA estimated that the pension funded status of a typical U.S. corporate defined benefit pension plan decreased about 1.3% in the first quarter. The average funding ratio fell from 83.1% to 81.7% during that time frame.

Funded status dropped over the quarter as liabilities for average plans outpaced assets, the report found. Global equity markets were up about 2.4% for the quarter. Plan discount rates decreased 19 basis points, Treasury rates decreased 19 basis points, while credit spreads remained unchanged, LGIMA found. Overall liabilities for the traditional 60/40 plan — 60% equities/40% aggregate bonds — returned 3.8 percentage points, while the plan’s assets increased by 2.2 percentage points, resulting in a funded status decline of 1.3%.

“It was a better quarter for plans that had previously implemented liability benchmarked de-risking strategies, as their asset portfolios slightly outperformed plan liabilities,” said Don Andrews, LGIMA’s head of liability-driven investment strategy.

He believes that the trend toward pension de-risking will continue into the foreseeable future, especially pension risk transfers or annuity buyouts of pension plans through an insurance company. Many companies have legacy exposure in their pension plans that corporate plan sponsors want to manage as effectively as possible. They are using LDI strategies to lock down the risk as much as possible. Many are turning to annuity buyouts of pension plans to get these pension liabilities off their books.

“Plans are tending to take more risk off the table given the rally in equity markets and for a lot of plan sponsors with legacy exposures, there is a significant amount of interest to de-risk,” he said.

Another trend Andrews is seeing in the pension industry is a “greater willingness among plan sponsors to utilize derivative structures. That has been a new development the last couple of years. Plans are more comfortable with derivatives. They’ve sort of decided they can put bands around the ultimate outcomes. Utilizing derivative structures can take the down side off the table for them,” he said.

These started to become popular after the market downturns in 2000 and 2008.

And although many companies have gotten out of the DB pension market in recent years, it is estimated that corporate DB plans still account for $4 trillion in retirement assets.

 “We continue to see significant interest in equity replication strategies from corporate pension plans, as plan sponsors seek to utilize capital most efficiently to control funded status outcomes.  In particular, option-based strategies optimized for the current market environment have been popular with our clients,” said Andrews. 

“As a benefits structure, DB plans were phased out of popularity recently by a number of corporate plan sponsors, but there is still a significant amount of corporate DB liabilities out there that will ultimately need to be hedged over the next few years,” he added. “Expect de-risking trends to continue.”

Source: Employee Benefit News