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US Pension Fund Fitness Tracker: Funded statuses decline sharply in second quarter of 2012
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 US pension plan’s funding ratio declined by five percentage points during the second quarter of 2012, from 83% to 78%. With this decline, it is estimated that plan funded statuses have remained approximately flat thus far in 2012, erasing all of the gains plans experienced in the first quarter.
“The first half of 2012, marked by early improvement in funded ratios followed by a sharp correction, bears a remarkable resemblance to the first half of 2011,” said François Pellerin, Head of Asset Liability Investment Solutions. “What is also similar is the outperformance exhibited by plans whose sponsors have adopted a dynamic pension risk management framework.”
The decrease in funding ratio was primarily driven by two factors:
- Equity markets performed poorly in an uncertain economic and political environment. Fixed income assets were mixed, with moderate increases across credit bonds, large increases in the US government bond markets and negative returns across international government bonds. Cumulatively, aggregate performance of the capital markets led to a decline of more than 1% on a typical US pension plan’s assets.
- Liability values were sharply higher over the quarter. US Treasury yields plummeted while credit spreads widened considerably, with the decrease in interest rates overwhelming the widening in credit spreads. For the quarter, pension discount rates are estimated to have decreased by approximately 40 basis points (bps), resulting in a large increase in pension obligations.
Exhibit 1: Sharp decline in funding ratio driven by strong increases in liabilities compounded by a slight decline in assets
US Pension Fund Fitness Tracker of the typical US corporate plan’s funding ratio
For the quarter, a typical plan’s asset pool returned approximately -1.1%, 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 performed poorly over the quarter as fear and volatility returned to the forefront of the investment landscape. Headlined by deteriorating economic indicators in the US and abroad, coupled with the ongoing saga of the European debt crisis, equity markets experienced moderate to severe declines over the quarter. Each month in the quarter saw increased volatility as negative news continued to dominate. While most US and foreign economic indicators pointed to a slowdown in the global economy, volatility and poor performance in risky asset markets hinged on the day-to-day news coming from Europe. From highly publicized national election results and the possibility of Greece exiting the European Union, to the potential of a complete meltdown of the Spanish banking sector, market sentiment swung wildly in May and June, leading to some weeks of very positive gains and others of large losses. As a result, the S&P 500 Total Return Index finished the quarter down approximately 2.8%, outperforming other developed markets, with the MSCI EAFE Index ending the quarter down approximately 7.1%.
Reflecting the turmoil across the global economies, bond markets were mixed throughout the quarter, with a considerable rally in US Treasuries leading to moderately positive returns for credit bonds. In the US, government bonds rallied with respect to credit bonds, as investors grew increasingly wary regarding the global economy and sought the safety of US government securities. In Europe, issues in the Spanish banking sector coupled with an ongoing lack of resolution to the sovereign debt crisis led to a decline in European government bonds. Of note, Spain indicated the need and received approval for a bailout totaling approximately $125 billion to help fight the woes of their banking sector. As a result of the immediate uncertainty of the impact of the bailout, yields on Spanish sovereign debt reached historical highs. Outside of Europe, China cut interest rates for the first time in four years, signaling concern that the global slowdown had reached one of the world’s most powerful economies. Overall, the 10-year US Treasury bond yield decreased by 57 bps, ending the quarter at 1.64%, while the 30-year US Treasury bond yield decreased by 59 bps, ending at 2.75%. High-quality corporate bond credit spreads, as measured by the Barclays Capital Long Credit A+ option-adjusted spread, ended the quarter approximately 21 bps wider. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) declined by approximately 40 bps. For the quarter, liabilities for a typical pension plan increased by nearly 6%. (Please see disclosures for assumptions and methodology.)
A note on UBS Global Asset Management’s recent paper “Pension Risk: Keeping on course with portfolio ‘GPS’ ”
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 on funded status of monitoring pension risk levels intra-quarter versus quarterly. In the paper, François:
- disputes current industry norms of monitoring plan allocation levels on a quarterly basis
- highlights the potential risks that may impact pension plans over a quarter
- discusses how through intra-quarter de-risking and allocation rebalancing plan sponsors can preserve funded status in market downturns
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.
For additional details, please contact the author:
François Pellerin, FSA, EA, CFA, CERA
Head of Asset Liability Investment Solutions
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. As of 12/31/2011, the asset index has been recalibrated based on the aggregate funding level of the participating plans in the UBS Global Asset Management Pension 500 Database, reflecting plan sponsor contributions over 2011.
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 service cost 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.