How Low Interest Rates Are Slamming Corporate Pension Funds

The funding status and levels of U.S. pensions is heading the wrong way. Despite a rising stock market, a report from the BNY Mellon Investment Strategy and Solutions Group is signaling that the funded Status of U.S. corporate pensions fell to 90.1%. On the flip-side, public pension plans, foundations and endowments gained in August. The biggest issue at hand still seems to be incredibly low interest rates. These keep pension funds from being able to meet certain income targets.

Falling interest rates led to higher liabilities and a lower funded status for the typical U.S. corporate pension plan in August. At the same time, rising asset values benefited public plans, foundations and endowments.

The typical U.S. corporate pension plan fell to 90.1% in August, and liabilities rose 3.3%, outpacing the 2.6% return for assets. This funded status is down 5.1% from the December 2013 high of 95.2%. The higher liabilities for corporate plans was shown to have resulted from the AA corporate discount rate falling to 4.11% over the month.

Public defined benefit plans in August exceeded their target by 1.3% as assets increased by 1.9%.  The public plans also exceeded their target by 7.6% from the past year.

For endowments and foundations, the real return in August was 1.1%, as assets returned 1.8%.   Private equity and real estate investment trusts returned 2.5% over the month. Foundations and endowments are ahead of the inflation plus spending target by 6.3% from the previous year.

Andrew D. Wozniak, head of fiduciary solutions at ISSG, said,

“Investors appeared to be torn between concerns about increased geopolitical tensions and optimism about the U.S. economy. Geopolitical concerns resulted in more interest in longer term corporate credit and government bonds, sending interest rates lower. Optimism about the economy helped to push equities and other risk-based assets higher.”

The threat of extremely low interest rates hurting pension funds is not a new development. It has hurt the insurance sector in many cases too. Still, many would have hoped that this zero-rate QE-fueled economy would have been freed up to get to a normalized interest rate environment. That hasn’t happened yet and is not expected to take place until 2015.

Here is one bit of food for thought — What if higher interest rates down the road are only moderately higher than the zero-rate or extremely low rate environment we are in now?

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