January 2018 Pension Finance Update
2018 started out with a bang for pension sponsors, with both stock markets and interest rates moving higher, producing the best month for pension finance in almost three years. Both model pension plans we track1 were up last month: Plan A gained 5%, while Plan B gained more than 1%:
Equity markets gained ground in January: the S&P 500 was up almost 6%, the NASDAQ gained more than 7%, the overseas EAFE index added 5%, and the small-cap Russell was up almost 3%.
A diversified stock portfolio gained 5%-6% in January.
Bonds lost close to 2% during January, as interest rates climbed more than 0.2% and credit spreads narrowed to levels not seen since the 1990s. Treasury bonds and long-duration bonds suffered the largest losses last month.
Overall, our traditional 60/40 gained 2%-3% in January, while the conservative 20/80 portfolio fell by less than 1% for the month.
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 January 31, 2018. 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 rose about 0.2% at most maturities in January, pushing pension liabilities down about 2% on the month – a bit less for short duration plans, a bit more for long duration plans.
Whereas 2017 was a year of pension plans grinding their way to steady improvement in funded status, 2018 has started with a nice pop for pension sponsors.
The graphs below show the movement of assets and liabilities for our two model plans so far this year:
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 in the near future).
Discount rates rose 0.2% last month. We expect most pension sponsors will use effective discount rates in the 3.6%-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 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.
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.