August 2018 Pension Finance Update

Pension sponsors enjoyed more good news in August, marking five consecutive months of improvement for pension finances. Both model plans we track[1]gained ground last month – traditional Plan A improved almost 1% while the more conservative Plan B gained less than 1%. For the year, Plan A is more than 8% ahead, while Plan B is up almost 2%:

Assets

Most categories of stocks were up during August, led by the NASDAQ, which gained more than 5% for the month. The small-cap Russell 2000 added more than 4% and the S&P 500 was up 3%, but the overseas EAFE index lost 2% on the month. Through August, the NASDAQ is up 17%, the Russell 2000 is ahead 14%, the S&P 500 is up 10%, and the EAFE index is down less than 3%.

A diversified stock portfolio gained more than 2% in August and is now up almost 9% for the year.

Bonds gained close to 1% during August, as interest rates moved modestly lower. Through August, a diversified bond portfolio remains down 2%-3%, with long duration bonds and corporates doing worst.

Overall, our traditional 60/40 gained more than 1% in August and is now up more than 3% for the year, while the conservative 20/80 portfolio gained 1% last month but is still down more than 1% through the first eight months of 2018.

Liabilities

Pension liabilities (for funding, accounting, and de-risking purposes) are now driven by market interest rates. The graph on the left compares our Aa GAAP spot yield curve at December 31, 2017, and August 31, 2018, and it also shows the (tiny) movement in the curve last month. The graph on the right shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during 2018:

Corporate bond yields declined about 0.05% during August, pushing pension liabilities up almost 1%. For the year, liabilities remain down 3%-5%, with long duration plans seeing the biggest drops.

Summary

Higher interest rates and solid stock market returns continue to provide the key storylines for pension finance in 2018.The graphs below show the movement of assets and liabilities for our two model plans so far this year:

Looking Ahead

Congress passed a budget in 2015 that includes a third round of pension funding relief since 2012. The persistence of historically low interest rates, however, means that pension sponsors that have only made required contributions will see contributions ramp up in the next few years as the impact of relief fades (barring an increase in long-term rates).

Discount rates dipped modestly last month. We expect most pension sponsors will use effective discount rates in the 3.9%-4.3% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2018, along with estimates for 2019. Pre-relief, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.

[1]Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds. We assume overhead expenses of 1% of plan assets per year, and we assume the plans are 100% funded at the beginning of the year and ignore benefit accruals, contributions, and benefit payments in order to isolate the financial performance of plan assets versus liabilities.