UBS Global Asset Management today announced that its US Pension Fund
Fitness Tracker, a quarterly estimate of the overall health of a typical
US defined benefit pension plan, shows pension funding ratios increased
by 6 percentage points in the first quarter of 2009.
According to the US Pension Fund Fitness Tracker, the typical US pension
fund started 2009 with a funding ratio of approximately 78% and ended
the quarter higher at approximately 84%.
This increase is attributable to higher discount rates which led to a
lower present value of pension liabilities. Corporate credit spreads
widened while interest rates rose, which led to a higher corporate bond
yield curve and pension discount rate. The decrease in liabilities was
partially offset by volatile equity markets that finished the quarter
lower, which decreased the value of the asset pool from which plan
participants' benefits are paid.
“Equity markets remained volatile throughout the first quarter and
finished the quarter down 11% as investors balanced weak economic and
corporate earnings reports against unprecedented fiscal and monetary
policy response," said Aaron Meder, UBS Global Asset Management's Head
of Asset Liability Investment Solutions in the Americas. “Overall, the
decline in assets was more than offset by a large decrease in
liabilities which led to an increase in the typical plan's funding ratio
for the quarter."
For the quarter, pension discount rates (which are based on the yield of
high quality investment grade corporate bonds) for a typical pension
plan increased over 100 basis points during the quarter, which decreased
the present value of pension liabilities. This decrease was offset
slightly by interest cost. For the quarter, the overall liability return
was -14%.
"As plan sponsors consider implementing an interest rate hedging
approach, it is imperative that they have a strategy in place to
implement the hedge as a function of interest rate, funding ratio and
calendar triggers,” said Meder. "For example, as interest rates begin to
increase, plan sponsors should add duration to their portfolios via long
duration bonds and/or interest rate derivatives to lock in their funding
ratio gains (as the present value of liabilities fall faster than the
value of assets) while reducing funding ratio risk."
From a long-term policy perspective, sponsors should use caution when
considering adding credit to the liability hedging component of an LDI
solution. During periods of economic stress, bond defaults rise which
will cause losses on the liability hedge, while pension liabilities are
not subject to default risk.
