April 2016 Pension Finance Update

Pension sponsors suffered another down month in April on the back of relentlessly lower interest rates. Both model pension plans we track1 lost ground last month: Plan A slipped 2% in April, and is now down more than 7% this year, while Plan B lost less than 1% last month and is now down more than 3% during 2016:

Assets

Stocks were mixed last month: The S&P 500 gained less than 1%, the small-cap Russell 2000 was up almost 2%, and the overseas EAFE index gained more than 2%, but the NASDAQ lost 2% during April. For the year, the S&P 500 is up almost 2%, the Russell 2000 and EAFE index are both flat, and the NASDAQ is down 4%.

A diversified stock portfolio gained less than 1% during April and is now even on the year.

Treasury bonds lost a fraction in April as rates edged up a bit, but corporate bonds added 1% on modestly declining rates. Credit spreads narrowed appreciably in March and are now lower than at the end of 2015. For the year, bonds are now 3%-6% ahead, with longer duration bonds and corporates doing best.

Overall, our traditional 60/40 portfolio gained a fraction of 1% in April and is now up more than 1% for the year, while the conservative 20/80 portfolio gained 1% last month and is now up almost 5% during 2016.

Liabilities

Pension liabilities (for funding, accounting, and de-risking purposes) are now driven by market interest rates. The graph on the left compares Treasury STRIPs yields at December 31, 2015 and April 30, 2016, and also shows the movement in rates last month. The graph on the right shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during 2016:

Treasury yields were up about 0.05% during April but remain down 0.40% this year. Meanwhile, corporate bond yields fell close to 0.10% last month, and are now down almost 0.50% in 2016, as credit spreads are at their tightest in more than a year.

The move pushed pension liabilities up close to 2% last month; liabilities are now 8%-10% higher than at the end of 2015, with long duration plans seeing the biggest increases.

Summary

Through four months, 2016 is shaping up as a challenging year for pension sponsors. Stocks have tread water, but corporate bond yields have pushed lower this year and are now in sight of all-time lows seen in early 2015, driving pension liabilities higher this year.

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

Looking Ahead

The Obama Administration and Congressional leaders passed a budget last fall that includes a third round of pension funding relief since 2012. The upshot is that pension funding requirements over the next several years will not be appreciably affected by current low interest rates (unless these rates persist). Required contributions for the next few years will be lower and more stable than under prior law.

Discount rates moved down almost 0.1% again last month. We expect most pension sponsors will use effective discount rates in the 3.4%-4.1% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2016, along with estimates for 2017. 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 cash balance plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds. For both plans, we assume the plan is 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.