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May 2018 Pension Finance Update

Pension sponsors saw modest improvement in funded status during May, due mainly to higher stock prices. Both model pension plans we track1 gained ground last month – both traditional Plan A and the more conservative Plan B improved a fraction of 1% in May. For the year, Plan A is 5% ahead, while Plan B is up 1%:

pension-funded-ratio-2018

Assets

Stocks were mixed but mostly positive in May: the S&P 500 gained 2%, NASDAQ added 5%, and the small-cap Russell 2000 increased 6%, while the overseas EAFE index slipped 2%. Through May, the NASDAQ is up 8%, the Russell 2000 is ahead 7%, the S&P 500 is up 2%, and the EAFE index has lost 1% for the year so far.

A diversified stock portfolio gained 2%-3% in May and is up more than 3% for the year.

Bonds gained about 1% last month as interest rates moved modestly lower and credit spreads widened a bit. Through May, a diversified bond portfolio is down 2%-4% for the year, with long duration bonds and corporates doing worst.

Overall, our traditional 60/40 was up close to 2% during May and is now up 1% for the year, while the conservative 20/80 portfolio added 1% last month and is now down 2% through the first five 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 May 31, 2018, and it also shows the 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:

GAAP-discount-rate-2018

Corporate bond yields fell bout 0.08% at most maturities in May, pushing pension liabilities up 1% on the month. For the year, liabilities are down 3%-5%, with long duration plans seeing the biggest drops.

Summary

Higher interest rates (up more than 0.40% so far this year) and positive, if modest, stock market returns have combined to produce positive results for pension sponsors during the first five months of 2018.

The graphs below show the movement of assets and liabilities for our two model plans so far this year:

pension-liabilities-performance

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 fell close to 0.10% last month. We expect most pension sponsors will use effective discount rates in the 3.8%-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.

2018-PPA-interest-rates

1Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance 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.

 

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