Great funding progress has been made by the average US private pension plan that has benefited during the last 12 months from rising equity values and rising bond yields. As the chart below suggests (thanks, Mercer), the funded status for corporate America now stands at 95%, having risen from a low of 70% in 2012 and 77% just 12-months ago. Given this great progress, now is not the time to sit on one’s laurels. With equity valuations at all-time highs, we believe that corporations would be best served by locking in these tremendous funding gains, even if the goal isn’t to freeze, terminate, and/or engage in a pension risk transfer for your specific pension plan.
Despite the fact that US interest rates continue to be near their lows, a cash flow matching strategy designed to defease the plan’s Retired Lives Liabilities will secure benefits chronologically and protect the funded status even in a rising rate environment, as assets AND liabilities will move in lock-step. Continuing with a traditional asset allocation potentially risks underperformance from both equities and core fixed income, given the latter’s interest rate sensitivity. Furthermore, a cash flow matching strategy can be accomplished with cash bonds and doesn’t need to involve more esoteric instruments, such as swaps and derivatives, which can introduce a different set of risks and provide no cash flows.
The last time that corporate America enjoyed a funding surplus was 2007. We know what soon transpired. It would be tragic if market declines once again sabotaged the funded status. We also got close to full-funding in 2013, but a significant decline in interest rates conspired to drive the collective funded status much lower. We don’t know when or by how much markets will move, but given their current valuations, there is likely less upside than downside. Secure your gains! Just like in Las Vegas, when you win BIG… take chips off the table!
Pingback: Confident or Irrational? – Ryan ALM Blog