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Aon Hewitt Analysis : rebound in global pension funding levels in third quarter 2010

Avatar of Sofia Ashmore

Sofia Ashmore

21 Oct, 2010.

Despite a major drop in global pension funding levels in August, strong asset performance in July and September helped boost the overall funded status of global pension plans in the third quarter of 2010, according to a new analysis from Aon Hewitt, the human capital consulting and outsourcing solutions business of Aon Corporation (NYSE: AON).

Aon Hewitt monitors and analyzes daily pension funding levels of U.S., U.K., Continental European, and Canadian companies in the S&P 500, FTSE 350, DJ Euro Stoxx 50 and TSX, respectively, through its Pension Risk Tracker tool. Aon Hewitt found that the funded status of global pension plans were 80 percent during the third quarter of 2010, up slightly from 79 percent in the second quarter. According to Aon Hewitt’s estimate, global pension assets increased by 12 percent during the quarter while pension liabilities increased by 10 percent over the same period.

“While the quarter closed with modest gains, market volatility continues to run at very high levels. Managing this risk remains the focus of pension plan sponsors as we head into year-end,” said Ari Jacobs, Aon Hewitt’s North American Retirement Solutions leader. “Plan sponsors that have taken steps to systematically de-risk their plans are benefiting from those decisions, while others continue to look for opportunities to gain control over their pension finances, including funding strategy, liability settlement and investment policy options.”

Regional Analysis

According to Hewitt’s analysis, strong pension asset performance attributed to improvements across all regions in the third quarter of 2010.

United States

Pension funded status for U.S. plans showed a marginal improvement in the third quarter, increasing from 80 percent to 82 percent. Strong equity markets—up 5 percent to 10 percent for the year—helped pension plans regain the losses they experienced in the second quarter. However, the corporate bond rates used for measuring pension liabilities plummeted to less than 5 percent in August—the lowest in over a decade. Even after a slight uptick in September, these rates fell between 0.3 percent to 0.5 percent from prior quarter levels. As a result, pension liabilities increased by 4 percent to 6 percent, negating much of the benefit from strong equity performance.

“The modest improvement observed at quarter-end masked what was another wild ride over the course of the quarter,” noted Joe McDonald, Aon Hewitt’s Global Risk Services leader in the U.S. “Funded status volatility continues to draw attention from senior management and has added to the momentum of pension de-risking strategies. The current interest rate environment has also prompted more plan sponsors to consider two- dimensional de-risking programs, which include explicit triggers based on both funded status and the future level of interest rates.”

United Kingdom

Accounting deficits declined for U.K. companies in the FTSE 350 index during the third quarter of 2010, although they were significantly higher than at the start of 2010. Assets increased by almost 10 percent, due to accounting-based liability values increasing approximately 7 percent. Despite market volatility during the quarter, the average funded ratio increased from 82 percent at the start of the quarter to around 85 percent. At one point during August, the average funded ratio fell to below 81 percent, which was one of the lowest values Aon Hewitt has recorded since it began tracking the data in January 2007.

Kevin Wesbroom, Aon Hewitt’s Global Risk Services leader in the U.K., said, “The continued volatility of funded ratios in the region suggests that many U.K. companies will be looking more actively at investment strategies that minimize exposure to asset market fluctuations. An increasing number of companies are taking steps to manage their pension risk, whether by amending benefits—such as freezing plans to existing members, liability management exercises—such as Enhanced Transfer Value exercises, or hedging investment risk.”

Continental Europe

Despite significant volatility, European pension plan sponsors saw little change in pension funding status in the third quarter, with an average funded ratio of approximately 66 percent. Pension funds in Europe saw a 6 percent average decline in funding ratios during the month of August, after rising as high as 69 percent at the end of July. A small recovery during September brought the quarter back in line with second quarter levels.

The low point at the end of August represented the poorest funding ratio since Aon Hewitt began its monitoring. Over that period of time, pension funding ratios were as high as 95 percent.

Matt Wilmington, Aon Hewitt’s Global Risk Services lead in Europe, said, “Like the U.S., continued volatility in the funded positions of European pension plans has resulted in greater interest in medium and long term de- risking strategies. As a result of revised life expectancy projections in the region and an expected rise in liabilities in certain European countries over the coming months, we expect to see further action among companies to reduce pension plan benefits and manage existing liabilities.”

Canada

Like Continental Europe, accounting deficits for companies in the S&P/TSX remained relatively unchanged during the third quarter of 2010. Strong asset returns, led by domestic equities, contributed to total assets increasing by more than 7 percent during the quarter. Unfortunately, this gain was offset by a significant decrease in corporate bond yields over the quarter, resulting in a 6 percent increase in liabilities. The net impact was that average funded ratios only increased incrementally, from 87 percent at the start of the quarter to 88 percent at the quarter’s end.

“Many organizations have been holding off on implementing liability driven investments (LDI) or risk management strategies, thinking that interest rates were due to increase,” said Rob Vandersanden, a principal in Aon Hewitt’s Calgary office. “However, yields have continued to trend downwards, effectively wiping out the strong investment returns of the past quarter.”

Source : Aon Press Release

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