US - The aggregate deficit in S&P 1500 pension plans increased by $73bn during August as equities and bond yields suffered a rollercoaster month, figures from Mercer show.
The deficit grew from $305bn as of July 31 to $378bn as of August 31 and corresponds to an aggregate funded ratio of 79% as of August 31, compared to a funded ratio of 83% at the end of July and 81% at December 31, 2010.
The decline in funded status was driven by a 5.4% drop in equities, and a fall in yields on high quality corporate bonds during the month, Mercer said, while discount rates for the typical US pension plan decreased by between 7-9 basis points. The analysis shows the S&P 1500 funded status peaked at 88% at the end of April and has since seen a 9% decline.
"August was a wild ride" said Jonathan Barry, a partner with Mercer's Retirement Risk and Finance Group. "We saw funded status plummet on August 8 due to the sharp fall in equity markets and declining Treasury yields, and a lot of ups and downs over the subsequent weeks.
"A small rally in equities in the last week of August, combined with widening credit spreads on corporate debt, provide some recovery from the early losses, but overall, the outcome was still bad news for pension plans."
Mercer said despite what seemed to be unprecedented market volatility, its analysis indicates that funded status swings like this are not as unlikely as one might think, and plan sponsors should be prepared for continued volatility going forward.
"For the typical pension plan invested 60% in equities and 40% in aggregate fixed income, the monthly volatility of funded status is between 3% and 4%," said Kevin Armant, a principal in Mercer's Financial Strategy Group.
"The decline in August shouldn't be seen as an outlier and there is the potential for even more volatility prior to the end of the year. What occurred in August 2011 was similar to the perfect storm of September 2008 with both falling interest rates and equity markets. The outcome wasn't as severe, however, and conditions are not considered as dire as they were during 2008."
"Nevertheless, it's important to keep in mind the potential consequences for those plan sponsors who haven't adjusted their management policies to reflect what was experienced during 2008. By and large, we have seen that those sponsors who had an effective risk management strategy in place by the beginning of this year have fared far better than those who didn't. Many of the strategies employed, such as liability driven investing, dynamic de-risking and liability transfers through lump sums or annuities, have proven quite effective and should be evaluated by all plan sponsors."
Mercer also noted another comparison to 2008 that may not be as favourable for plan sponsors. "After the market downturn in 2008, Congress passed a version of funding relief that helped plan sponsors reduce their required contributions to plans in 2009 and 2010." said Barry.
"For the most part, those techniques that were used to lower contributions are no longer available, and plan sponsors will likely face significant funding increases in 2012 and beyond, especially if the conditions from August continue through year-end."
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