April 2017 Pension Finance Update
Pension plans broke even in April and remain in positive territory through the first four months of 2017. Last month, rising stock markets neutralized the impact of higher pension liabilities (driven by lower interest rates) for both model plans we track1 . Through April, Plan A is up almost 3% and Plan B is up almost 1% so far this year.
Stocks rose in April: the S&P 500 gained 1%, the NASDAQ was up more than 2%, the small-cap Russell 2000 rose more than 1%, and the overseas EAFE index gained more than 2%. For the year, the NASDAQ is 12% ahead, the S&P 500 is up 7%, the Russell 2000 has gained almost 4%, and the EAFE index is up more than 10%.
A diversified stock portfolio gained 1%-2% in April and is now up more than 8% through the first four months of 2017.
Bonds gained 1% or so in April as interest rates edged down modestly. For the year, bonds are up 2%-3%, with longer duration bonds and corporates doing best.
Overall, our traditional 60/40 portfolio gained more than 1% in April and is now up more than 5% for the year, while the conservative 20/80 portfolio was up 1% last month and is now up 3% during 2017.
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, 2016, and April 30, 2017, 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 2017:
Yields moved down close to 0.1% across most maturities last month and are now more than 0.1% lower than where they ended 2016.
The move pushed pension liabilities up 1%-2% in April, leaving liabilities about 2%-3% higher during 2017, with long duration plans seeing the biggest increases.
Stock markets have generated solid gains during the first four months of 2017, producing improvements in funded status for most pension sponsors.
The graphs below show the movement of assets and liabilities for our two model plans this year:
Congress passed a budget in 2015 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% last month. We expect most pension sponsors will use effective discount rates in the 3.7%-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 2017, along with estimates for 2018. Pre-relief, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.
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.