email : Webview : The Funded Status Whipsaw for Corporate Pension Plan Sponsors

The Funded Status Whipsaw for Corporate Pension Plan Sponsors

By: Kathryn Pizzi, CFA, ASA, Senior Investment Consultant

The first half of the year, and likely all of 2020, will no doubt be remembered as a remarkable time in our history. The deep rippling effects of the extraordinary efforts taken to stave off the impact of the COVID-19 pandemic have been felt both personally and economically, and could last for years to come.

The unrelenting spread of COVID-19 around the globe ignited panic across nearly all facets of the global economy. Uncertainty regarding the spread and severity of the virus as well as its potential impact on the economy caused massive destabilization in capital markets and prompted the U.S. Treasury and Federal Reserve to take swift, decisive action.

While these actions were essential to keep markets and the economy functioning, the funded statuses of corporate pension plans across the country were left whipsawed, see Graph 1. (Funded status represents the ratio of pension assets to pension liabilities.)

Before we address what caused this whipsaw, we will offer some background (warning, this gets a bit technical!). Current and future pension benefits owed to participants are valued based on the yields (interest rates) of high-quality corporate bonds. As these rates decrease, today’s value of those future benefit payments (i.e., the liability) increases. Likewise, as rates increase, the liability decreases. Unfortunately, due to the asymmetric nature of the benefit payments (which is called convexity), liabilities go up faster from a rate decrease than they go down from a rate increase.

As markets panicked, the Federal Reserve slashed interest rates to zero. On the surface, one would assume the combination of lower interest rates and massive equity losses would cause the funded statuses of corporate pensions to decline sharply from the double whammy of liabilities increasing and assets decreasing. Surprisingly, the average funded status of the 100 largest U.S. pension plans generally improved at the end of March compared to February (from 83 percent to 86.2 percent¹), despite the heavy investment losses. The reason behind this counterintuitive result was “spread widening,” or the increase in additional yield above a Treasury bond that an investor demands for assuming credit or default risk.

Not since the Great Financial Crisis have corporate spreads increased as significantly as they did in March. The surprising result was a welcome bright spot in an otherwise dismal outlook for many pension investors.

However, the bright spot quickly dimmed as the Federal Reserve’s stabilization efforts took hold and spreads quickly declined. Investors no longer needed the enticement of additional yield to be convinced to buy corporate bonds instead of Treasuries – the ultra-low Treasury rates and the Federal Reserve’s commitment to support the bond market provided plenty of incentive.

Consequently, the solace that many pension Plan Sponsors enjoyed in March evaporated quickly even as equity markets rebounded sharply. The average corporate pension plan’s funded status declined from 86.2 percent in March to 83.7 percent in June¹.

Looking forward, while the trajectory of the virus has been improving globally, numbers in the U.S. are not quite as encouraging. Combined with political headwinds and uncertainty around the November election, we expect that low rates are here to stay for at least the balance of 2020.

So, there’s good news and bad news for corporate pension Plan Sponsors. The good news is that we don’t believe it’s likely that corporations will see another whipsaw in their plan’s funded status in the back half of 2020. Unfortunately, that’s also the bad news.

For more information, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.

¹Milliman 100 Monthly Pension Funding Index, June 30, 2020

Kathryn Pizzi is Senior Investment Consultant of Fiduciary Investment Advisers, LLC which is a wholly owned subsidiary of DiMeo Schneider & Associates, L.L.C.

This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. The information contained herein is intended for the recipient, is confidential and may not be disseminated or distributed to any other person without the prior approval of DiMeo Schneider. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent future expectations and actual returns, volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is a possibility of a loss.

Schedule an Appointment
Or Call 800.392.9998

Learn More About Us
Or View our Research

Manage your preferences | Opt out using TrueRemove™
Got this as a forward? Sign up to receive our future emails.
View this email online.

500 W. Madison Street Suite 1700
Chicago, IL | 60661 US

This email was sent to .
To continue receiving our emails, add us to your address book.