The financial markets' poor showing in August left U.S.corporations' defined-benefit pension plans even deeper in the red.And there are additional challenges on the horizon for DB planfunding, including the prospect that the Federal Reserve will tryto bolster growth by pushing long-term rates lower. That couldlower the discount rates companies use to measure pensionobligations and increase the size of those obligations.

Mercer, the HR consulting company, estimates the aggregatepension deficit at S&P 1500 companies grew by $73 billion inAugust to total $378 billion. Pension plans took a double hit lastmonth, with the sell-off in stocks eroding their assets at the sametime the decline in interest rate caused their liabilities togrow.

The aggregate funded ratio of the S&P 1500 plans was 79% atthe end of August, according to Mercer, down from 83% at the end ofJuly and 81% at the end of 2010.

Fed policy makers pledged in August to keep their target forshort-term rates at the current low level through mid-2013.Speculation now is that policy makers could announce that they willtry to lower longer rates by adding more long-term Treasuries tothe central bank's portfolio, in what would be the Fed's thirdround of quantitative easing, or QE3.

“Just a few weeks ago, funds were saying: 'We don't think yieldscan go any lower,'” says David Kelly, a principal in Mercer'sfinancial strategy group. “Now we have speculation on QE3 that saysyields could go lower.”

Such a move “could be a substantial negative” for many pensionplans, Kelly says. Pension plans generally measure theirliabilities using a discount rate derived from longer corporatebonds; lower bond yields mean bigger liabilities. Kelly estimatesthat a 25-basis-point decline in yields causes pension funding toworsen by about 2%.

“The big question is, if the Fed is buying down Treasuries atthe end of the curve, will corporates follow them down or willspreads widen?” Kelly says.

The spread between Treasury and corporate yields has widenedrecently as investors exited riskier assets and gravitated towardthe safety of Treasuries, he notes. “It is likely, you would think,that if [yields on] Treasuries do go down extremely low, thatcorporates spreads will not blow out all of the way to compensate,”he adds.

Analysts say the deterioration in pension plans' funded statusunderscores the importance of considering strategies, such asliability driven investing, that shield plans from marketvolatility.

Kelly says that while a few plans implemented liability-driveninvesting strategies a few years ago, those that didn't have beenreluctant to make the move while rates are so low. He says onceyields begin to rise again, the demand from pension plans movingmore assets into fixed-income securities may limit the increase inyields.

“Once yields go up, there's going to be a strong bid,” he says.“That probably puts some pressure on the ability for yields to getvery high.”

Mercer also notes that funding relief that Congress enacted in2008, in the wake of the financial crisis, is expiring, which meansplan sponsors may have to make significantly larger contributionsto their plans starting next year.