Rising Rates Unlikely to Save Pensions

Corporate pension plans need more than the Fed to close the funding gap.

Projected interest rate hikes in 2017 are unlikely to dig corporate pensions out of the hole.

The US Federal Reserve announced on December 14 its intentions to raise rates throughout 2017. But experts don’t see this making much difference for struggling pensions.

 

“It is not just the increase in rates that matters but the increase relative to what is priced into the market,” said Bob Collie, chief research strategist at Russell Investments’ Americas institutional division. “If interest rates go up only at the rate the market expects, that will not help pensions at all.”

 

Though a sustained low-interest rate environment makes retirement provision difficult, many factors have to combine for pension plans to see improved funded ratios, Collie indicated. 

 

“The single biggest factor in pension funding levels is interest rates,” Collie said. “But the FOMC [Federal Open Market Committee] raising rates does not automatically mean pension funding will go up.”

The ultra-low interest rates since 2008 have been detrimental to corporate pensions, whose liabilities are valued based on interest rates.

“Defined benefit pensions of US and European companies have seen their funding gaps worsen since the onset of the crisis,” according to an International Monetary Fund report. “This reflects a combination of low asset returns (especially on safe assets, such as sovereign bonds) and falling interest rates.”

“We looked at the largest pension plan sponsors in the United States, those with pension liabilities exceeding $20 billion,” Collie continued. “We have seen (the) pension funded status of this $20 billion club hasn’t really recovered since 2008.”

Although markets and interest rates usually have the largest impact on funded status, the current environment means that moving the needle is going to require company contributions, he added.

“[Even as] the stock market has increased past pre-crisis levels… [low] interest rates have held back pension funded status,” he said. "When you analyze how (the) funded status has moved since 2008, it’s pretty clear that interest rates have been the reason most plans are still not back to a strong funding position.”

According to Collie, plans won’t see strong funding positions any time soon, despite climbing interest rates on the horizon.

“When it comes to pension funds, the math is pretty simple,” he explained. “When interest rates are low, it is more expensive to put aside money for retirement."

Related: IMF Calls for Fund Manager Stress TestsProjected Rate Hikes Likely Fall Short for Underfunded Pensions

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