Defined benefit crunch has global reach

While most developed financial markets have experienced volatile equity values in 2010, returns have been generally positive for the past year.

But, according to Mercer’s analysis, plan sponsors of large DB programs are still likely to report larger deficits compared with the previous year.

Falling corporate bond yields are causing major trouble for pension funds.

In some markets, bond yields have fallen by more than a quarter. In the U.S., since the end of June 2008, AA corporate bond yields had fallen from 6.97% to just under 5% at the end of August 2010.

Recent analysis of the S&P 1500 published by Mercer earlier in September revealed that the U.S. has just experienced its largest ever aggregate pension deficit.

“A 50 basis points fall in discount rates roughly results in a 10% increase in liabilities for a pension scheme,” said Frank Oldham, Mercer’s global head of pension risk consulting.

“As a result, measures of pension scheme liabilities have increased faster than the value of the assets held across numerous markets. The result is even larger deficits on company balance sheets.”

Plan sponsors are also trying, more than ever, to do what they can to reduce and eliminate the risks associated with the operation of DB plans.

“The trend is for companies to implement investment strategies that result in higher correlation between how assets and liabilities behave, hedging more of the funded status risk,” said Mercer’s financial strategy group leader, Mick Moloney.

“This trend will only accelerate given the current market conditions. Companies with mature plans will be seeking to implement specific strategies to dynamically reduce pension plan financial risk over time as the plan’s funded status improves.”

Research from Greenwich Associates’ 2010 U.K. Investment Management Study revealed that more employers are trying to get plan members to transition out of DB programs.

One in 10 U.K. DB plans has implemented a full or partial buyout, and 16% expect to implement some form of buyout by the end of 2010, according to the study.

One in 10 DB plan sponsors also indicated plans to offer members incentive payments or enhanced transfer values to encourage the movement of employees out of DB plans and into defined contribution structures.

Canada weathering the storm
Canada’s economy wasn’t crippled by the financial crisis, but companies are still experiencing record DB deficits, the Mercer report said. Many investments are also performing poorly, and combined with declining AA corporate bond yields, the conditions are driving up liabilities. As a result, pension scheme deficits overall are expected to more than double, from about $20 billion to just under $50 billion, according to Mercer.

U.S. still hurting
There is major concern over the level of AA corporate bond yields, which have fallen steadily in 2010 to the lowest levels in a decade (4.94% at the end of August). These lower yields are translating into higher liabilities.

U.K. pension liabilities also rising
Like the American market, the U.K. is experiencing a similar decline in corporate bond yields. In the U.K., benefits are linked to inflation, so liabilities have been more stable over the year, but they have still reached historic levels.