Market volatility hammers funding ratios

According to Hewitt Associates, funding ratios recovered somewhat, to 94% by May 28, although the turbulent markets are resulting in significant daily swings into deficit positions.

The firm also notes that the volatility is coinciding with plan sponsors’ efforts to comply with International Financial Reporting Standards, which require the funding position of the plan (and the inherent volatility) to sit directly on the sponsor’s balance sheet.

“The dramatic swing in the funded ratio of these plans underscores how vigilant plan sponsors have to be in monitoring risk factors,” says Thomas Ault, a senior retirement consultant in Hewitt’s Vancouver office. “The current volatility in the markets requires plan sponsors to take appropriate steps to manage risk. While a certain amount of pension risk is healthy, plan sponsors need to determine their comfort level and then adjust their strategies with the changing landscape—as interest rates, currency exchange rates and inflation—among other risk factors—impact investment returns.”

Meanwhile, Britain soldiers on
U.K. plan sponsors are riding out the same rough seas as their Canadian counterparts, but have yet to experience the downward pressure, according to Towers Watson.

The consulting firm finds that pension deficits actually shrunk by £7 billion during May. The future rates of inflation anticipated by markets were lower than anticipated at the end of the month, reducing the expected cost of inflation-linked pension payments.

As of May 31, U.K. equities have returned -6.1% for the month—the worst monthly return since February 2009 and the second worst since the height of the financial crisis.

However, markets are expecting inflation to average 3.5% over the next 20 years (compared with the 3.7% expected at the end of April) contributing to a £18 billion fall in liabilities over the same period. Nominal interest rates on the corporate bonds used to calculate pension liabilities increased slightly in May, but lower inflation means real interest rates are significantly higher, reducing the present value of liabilities falling due in future.

Towers Watson estimates that the combined pension deficits of FTSE350 companies have fallen from £77 billion to £70 billion since the end of April.

“This might seem a perverse result, but it arises because it isn’t only stock markets that are volatile,” says John Ball, head of defined benefit consulting with Towers Watson. “An unprecedented combination of economic conditions makes it harder to predict what will happen to inflation over the coming years, and when inflation expectations jump around, so do pension deficits. The same news that drives share prices higher or lower can also influence inflation expectations, so the impact on pension deficits will not always be as it appears at first sight.

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