A new regime of higher bond yields is pushing defined benefit pension plan sponsors around the world to diversify asset holdings and increase liability-driven investment flows, according to a new report by FTSE Russell.
Despite a nearly 10-year low for credit spreads, high absolute yields increased discount rates sharply for DB plans, particularly in the U.S. and the U.K., creating an environment of surpluses for these plans. For some plans, this was the first period of surplus since before the global financial crisis, noted the report.
“One of the key consequences of the new world of higher rates and bond yields is higher discount rates applied to the future liabilities of pension funds and insurance companies, reducing the size of these liabilities,” said the report.
Discount rates vary across all G7 country pension plans with some plans requiring the use of government bond yields as discount rates while others can access corporate bond yields. Plans have enjoyed a favourable combination of higher discount rates on liabilities and stronger equity markets since 2022, according to the report.
It also recognized the new environment is giving plans a variety of options to approach discount rates for liabilities, including to assess scheme funding or to stress test liabilities, over and above strict regulatory requirements.