Wider spreads in financials help with pension liabilities

Here is an informative e-mail exchange discussing the discount rate used for pension liabilities:
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Hey Kevin,

Did you see the Milliman study about underfunded pensions? Rates coming down is killing them as discounted liabilities explode.

Sacramento Bee: Milliman, Inc., a premier global consulting and actuarial firm, today released the results of its latest Pension Funding Index, which consists of 100 of the nation's largest defined benefit pension plans. In November, these plans experienced a $7 billion decline in market value and a $1 billion increase in pension liabilities. While declining assets drove the deficit growth, the 4.53% discount rate—the lowest in the 11-year history of this study—continues to be the big story.

"So long as we have low discount rates we'll have no choice but to hope for improved asset performance," said John Ehrhardt, co-author of the Milliman Pension Funding Study. "As 2011 draws to a close it seems increasingly likely that this will be a lost year for pension funding. In the coming weeks, plan sponsors will be closely monitoring both the discount rate and the market value of these assets, with the hope of starting off 2012 with at least some upward momentum."

How's that impacting you guys?  As treasurer you must be freaking out.

All the best,
Ron
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Hi Ron,

Thanks for sending this.  It's really no big deal for us - our pension discount rate has not changed.  In fact it's actually a little higher this year.  So we don't need to kick in additional cash into our pension.

See you next week.
Kevin

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Kevin - are you serious about the discount rate?  10-y treasury yield is lower by 114bp from a year ago.  How is that possible?  Everyone is telling me that pensions are struggling because the NPV of the liabilities is exploding due to massively lower discount rates.

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Ron- we use the 10-year AA corporate composite yield as the discount rate. And that hasn't changed much.

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Kev - I am still having trouble wrapping my head around this.  Do you have a chart?

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Sure.  Check this out - it's pretty cool.  We measure our discount rate once a year in mid-October.  Treasury yields came off but AA spreads blew out, keeping our discount rate stable.

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Kevin - that's crazy.  AA spreads blew out that much?  Obviously enough to compensate for the falling treasury yields.  Why?

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Well Ron, how many corporations do you know that are AA?  Not many.  So a big chunk of the "AA Index" are financials.  And as you know with the madness in Europe, US financial spreads blew out, really moving out the whole AA spread.

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Amazing. Who could have thought that all the mess in Europe will actually help with your pension liabilities. So you guys are all set with your pension.
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Yes.  Until next October.

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