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November 12, 2010 at 10:04 AM
After the midterm elections, the Federal Reserve passed a quantitative easing program (QE2) that could potentially cause further deterioration in U.S. pension plan funding, especially if it lowers long-term interest rates, according to Mercer in a news release on Tuesday.
Benefit plan sponsors are looking for ways to lessen the impact of pension volatility on their balance sheets and income statements so that they can focus on their core businesses. However, Mercer advises that many companies are contending with significant pension deficits and struggling with balancing risk reduction and increasing cost during a time of profitability challenges and expenses reduction pressures.
For the new round of quantitative easing, the Fed’s primary tool is their commitment to purchase roughly $600 billion in Treasuries over a nine-month period. These purchases are designed to lower long-term interest rates for the near term, and reduce the potential for relief on the pension equation liability side. Typically, pension plan liabilities are valued using yields in high-quality corporate bonds, not Treasuries. If the purchase doesn’t change the spread between corporates and treasuries, then pension discount rates are expected to stay at all time lows for the short term.
As for longer term, the Fed’s actions could cause inflation to creep upward, drive interest rates higher, and potentially lower liabilities. However, significant movement before late 2011 or early 2012 is highly unlikely. "The short run effect is a greater demand for Treasuries, which will pressure short and intermediate rates to remain low. The longer term impact of QE2 is to risk higher actual inflation than the market is currently pricing." said Louis Finney, chief economist for Mercer, in a statement.
