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US Pension Fund Fitness Tracker: Funding ratios improve during the Fourth Quarter of 2011
The UBS Global Asset Management US Pension Fund Fitness Tracker, a quarterly indicator highlighting the underlying health and volatility of a typical US corporate defined benefit pension plan, found that the typical pension plan’s funding ratio improved by two percentage points during the fourth quarter of 2011, to 73% from 71%. Despite the rebound in the final quarter, however, the typical pension plan’s funding ratio dropped during the full year 2011 by an estimated 11 percentage points, from 84% to 73%.
“Plan sponsors have experienced tremendous funded status volatility during 2011," said François Pellerin, Head of Asset Liability Investment Solutions. "Many people believe the upcoming year could be even more volatile. However, contribution and financial statement risk associated with such periods can be mitigated by adopting an efficient pension risk management program.”
The increase in funding ratio was primarily driven by two factors:
• Returns were positive in most asset classes. Fixed income assets were flat to slightly up over the quarter, and equity markets, while volatile, performed strongly over the quarter, leading to returns of approximately 5% on a typical pension plan’s assets.
• Liability values increased moderately. US Treasury yields declined and credit spreads tightened, leading to a lower corporate bond yield curve and pension discount rate. For the quarter, pension discount rates are estimated to have fallen by approximately 12 to 15 basis points (bps), resulting in an estimated increase in pension obligations of slightly more than 2%.
Exhibit 1: Modest increase in funding ratio driven by increases in assets outpacing slightly positive increases in liabilities
US Pension Fund Fitness Tracker of the typical US corporate plan’s funding ratio
Sources: UBS Global Asset Management, Barclays Capital, Markit.
For the quarter, a typical plan’s asset pool returned approximately 5.1%, based on the average corporate plan's reported asset allocation weightings from the UBS Global Asset Management Pension 500 Database and publicly available benchmark information. Most risky asset markets ended the quarter performing well, despite considerable volatility caused by fluctuating sentiments over the European sovereign debt crisis and an uncertain US economic outlook. However, towards the end of the quarter, increased holiday shopping combined with improving indicators, helped assuage fears of entering into another recession and helped bolster domestic equity markets. The S&P 500 Total Return Index finished the quarter up approximately 11.8%, outperforming other developed markets, with the MSCI EAFE Index ending the quarter up approximately 3.3%.
Bond markets were generally mixed throughout the quarter, as concerns over the health of the global economy and the euro zone crisis fluctuated throughout the quarter, leading to large swings in demand for bonds. Overall, as economic sentiments improved at the end of the quarter, investor demand for global bonds remained flat with a slightly increased appetite for credit bonds, as evidenced by the tightening of credit spreads over the quarter. The 10-year US Treasury bond yield declined by 4 bps, ending the quarter at 1.88%, while the 30-year US Treasury bond yield decreased by 2 bps, ending at 2.89%. High-quality corporate bond credit spreads, as measured by the Barclays Capital Long Credit A+ option-adjusted spread, ended the quarter approximately 7 bps tighter. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) decreased by roughly 12 to 15 bps. For the quarter, liabilities for a typical pension plan increased by a little more than 2%. (Please see disclosures for assumptions and methodology.)
A note on UBS Global Asset Management’s recent white paper “Pension risk management: The discipline needed to protect contributions”
Large deteriorations in funded status such as the one experienced during 2011 add to sponsors already significant future contribution burden. In his recent paper, François Pellerin, head of UBS Global Asset Management’s Asset Liability Investment Solutions group, analyzes the impact of contributions made to corporate pension plans relative to market performance. In the paper, François:
- dispels a common misconception that market performance is the main determinant of funded status
- highlights the importance of protecting contributions through the implementation of a pension risk management framework
- discusses how funded status may drive a plan sponsor's actions
- sources a recent UBS Global Asset Management study of 500 US plan sponsors
The paper is an example of how we think about pension risk management and is a precursor to how UBS Global Asset Management can implement a variety of solutions and products to seek improved outcomes.
The paper can be found at: http://www.ubs.com/1/e/globalam/gis/whitepapers.html
Disclosures and methodology
Funding ratios measure a pension fund’s ability to meet future payout obligations to plan participants. The main factors impacting the funding ratio of a typical US defined benefit plan are equity market returns, which grow (or shrink) the asset pool from which plan participants’ benefits are paid, and liability returns, which move inversely to interest rates.
Liability indices: Methodology
The iBoxx US Pension Liability Index – Aggregate mimics the overall performance of a model defined benefit plan in the US, taking into consideration the passage of time and changes in the term structure of interest rates. The index is based on actual liability profiles, and mimics the investment grade yield curve. It is therefore more appropriate than most existing indices for measuring the performance of defined benefit plans. This index (along with its related active member and retired member indices) is published daily, using the LIBOR interest rate swap curve as the discount curve, a highly liquid universe. This provides the flexibility to use combinations of the indices in order to accurately represent customized liability profiles based on a plan’s specific participant population.
Pension Protection Act (PPA) liability returns are approximated by the Barclays Capital US Long Credit A-AAA Index. This index broadly reflects the duration and credit characteristics of the PPA discount curve that is used to discount expected pension benefit payments for US defined benefit pension plans.
Asset index: Methodology
UBS Global Asset Management approximates the return for the ”typical” US defined benefit plan using the reported asset allocation of the UBS Global Asset Management Pension 500 Database. The series is constructed using the aggregate asset allocation weightings and publicly available benchmark information, with geometrically linked monthly total returns.
Pension Fund Fitness Tracker: Methodology
The US Pension Funds Fitness Tracker is the ratio of the asset index over the liability index. Assuming all other factors remain constant, it combines asset and liability returns and measures the impact of a “typical” investment strategy on the funding ratio of a model defined benefit plan in the US due to interest rollup, change in interest rates and typical asset performance, but excludes unique plan factors, such as contributions and benefit payments.
The UBS Global Asset Management Pension 500 Database
The UBS Global Asset Management Pension 500 Database is a proprietary database that is based on the analysis of 500 public companies sponsoring large defined benefit plans. The information was extracted from the companies’ 10-K statements. The study may include figures for companies’ nonqualified and foreign plans, both of which are not subject to ERISA.
The aggregate asset allocation is based an equally weighted average of the 500 companies included in the database. The aggregate asset allocation includes equities, fixed income, hedge funds, private equity, real estate, and cash.