Funding ratios have improved in the first quarter (see chart below), supported by higher interest rates and decent equity returns. Liberation Day came just after the close of the quarter, so we can expect a slight worsening from that point onward. If trade tensions trigger another leg lower in 20Y rates and a sell-off in equities, we could see funding ratios falling again. Having said that, for now, funds seem in a good position to transition.
On the transition date, any funding ratio excess (above c.105%) will be allocated to each participant’s individual pot. In effect, that would mean that those in retirement would suddenly see an increase in their pension payments. In the new system, most funds will hedge such liabilities by close to 100%, which is likely higher than the current overall hedging ratio. As such, a higher funding ratio on the transition date could imply a demand for shorter-dated hedges.
For younger participants, however, a higher funding ratio is unlikely to change the demand for interest rate hedges too much. These longer-dated exposures will no longer need the same amount of interest rate hedging from a regulatory perspective compared to the old system, and funds will therefore likely still have to reduce their longer-dated hedges.
