The Impact of 2008 Is Still Being Felt by Pension Plans

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In many ways, the economy has moved past the global credit meltdown of 2007-2008 and ensuing financial crisis: U.S Gross Domestic Product (GDP) has been growing for more than seven years¹ and U.S. stock market lows are similarly far in the rear view mirror². But while many key metrics have long since regained pre-crisis levels, pension plan funded status remains stubbornly poor: the shadow of 2008 still falls on these plans.

Falling asset values dragged funding down, but it’s falling interest rates that have kept it down

At its low in March, 2009, typical funded status (on a fully marked-to-market basis) of pension plans in the United States had fallen by some 30%.³ That was mainly the result of a sharp fall in asset values. But while asset values have subsequently recovered, funded levels have not; it’s my view that it’s been the liability side of the balance sheet—not the asset side—that has hindered the recovery.

The chart below shows (a) how a representative pension plan that started 2008 93% funded might have fared since then and (b) what that same path might look like if the interest rates used for liability valuation had remained unchanged. (These use the same assumptions as for the hypothetical open plan described in this 2015 research note.)

Source: Russell Investments research. Example impact on hypothetical plan’s funded status since January 2008 of (a) asset returns and (b) asset returns and changes in the liability discount rate

¹ World Bank. United States GDP in US$. http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=US

¹ Macro Trends. Dow Jones 10 year Daily Chart. http://www.macrotrends.net/1358/dow-jones-industrial-average-last-10-years (updated daily)

¹ “Largest corporate DB plans see no gains in funding.” Pensions & Investments. April 18, 2016.http://www.pionline.com/article/20160418/PRINT/304189988/largest-corporate-db-plans-see-no-gains-in-funding

The dotted line—which excludes the impact on liability values of changes in the discount rate—shows a potential full recovery to pre-crisis funded status by 2014. Even given the decline since then, it shows a likely funded status just a few percentage points down from pre-crisis levels. (Indeed, if we were to allow for the fact that most plan sponsors have made contributions to their plans in excess of new benefit accruals, even that gap would go away.)

But the dotted line is a hypothetical line, ignoring the impact of changes in interest rates. When we make allowance for those changes we see a different picture. This hypothetical plan’s liabilities were valued using an effective interest rate (EIR) slightly over 7% in March 2009, but that EIR would have fallen below 3.5% by the end of July 2016. (Note: the EIR varies depending on the profile of the liabilities; EIRs are currently even lower for plans with shorter average liability duration.) The fall in the discount rate would have prevented the recovery in funded status that might have otherwise have occurred.

So funded status has stayed stubbornly low, and pension plans have remained stubbornly underfunded both in this example and in the real world. I believe it was falling asset values that has dragged funding down, but it’s likely been falling interest rates that have kept it down. This example highlights just how important it is for the two sides of the pension plan balance sheet to be managed together.

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