February 2016 Pension Finance Update
Following a difficult January, pension woes continued in February, marked by weak stock markets and falling interest rates. Both model pension plans we track lost ground again last month: Plan A fell 2% in February and is now down more than 8% this year, while Plan B dropped 1% last month and 4% total in the first two months of the year:
Stocks mostly lost ground again in February: the S&P 500 and NASDAQ both lost 1%, the small-cap Russell 2000 was flat, and the overseas EAFE index dropped 4%. Through two months this year, the S&P 500 is off 5%, while, the NASDAQ, Russell 2000, and EAFE index are all down more than 8%.
A diversified stock portfolio lost 1% In February and is now down 7% through the first two months of 2016.
Bonds enjoyed another good month due to lower interest rates, adding about 1% during February. For the year, bonds are now 3%-4% ahead, on the month, with longer duration bonds doing best, and Treasuries outperforming due to higher credit spreads.
Overall, our traditional 60/40 portfolio was flat in February and remains down 3% for the year, in January, while the conservative 20/80 portfolio gained 1% last month and is now up 1% during 2016.
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 February 29, 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 dropped about 0.15% across most maturities last month and are now down more than 0.40% this year. Corporate bond yields fell as well, and are now down 0.30% in 2016, with wider credit spreads accounting for the difference.
The move pushed pension liabilities up 2% last month; liabilities are now 5%-6% higher than at the end of 2015, with long duration plans seeing the biggest increases.
Two months into 2016, pension sponsors find themselves in a hole, due to falling stock markets and lower interest rates. The move this year has left rates less than 0.50% above the all-time lows seen in January of 2015.
The graphs below show the movement of assets and liabilities for our two model plans this year:
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 about 0.1% last month. We expect most pension sponsors will use effective discount rates in the 3.6%-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 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.