Over the past quarter, the typical corporate defined benefit (DB) plan may have experienced a modest erosion in funded status. However, the factor that helped DB plans, rising credit spreads which led to declines in liability values, is quickly turning into a challenge as declining spreads and interest rates are both driving liability values back higher. Understanding this risk – and managing plan asset strategy accordingly — will enable plan sponsors to navigate what we expect to be a continued period of market volatility.
The Bloomberg Barclays U.S. Corporate Long AA Index (the “Long AA Corp Index”) is a reasonable proxy to analyze historical spread volatility associated with the discount rates used by corporate plan sponsors. The duration of the Index is 16.3,1 reflective of many plans’ liabilities and the long history of the data available allows us to observe how the yield of the index and its components — duration equivalent Treasury yields and the implicit credit spreads — respond to different events over time. As of April 15, the yield on the Long AA Corp Index was 2.81% and the option adjusted spread was +169 basis points (bps) compared to 3.13% and 84 bps, respectively, at the end of 2019.