July 2022 Pension Finance Update

Pension finance enjoyed a strong month in July due to rising stock markets. Both model plans1 we track gained ground last month: Plan A improved almost 2% and is now up 4% for the year, while the more conservative Plan B added 1% and is now down less than 1% through the first seven months of 2022:

Assets

Stocks enjoyed their best month of the year, led by US markets. A diversified stock portfolio gained 8% in July but remains down almost 15% so far during 2022:

Interest rates fell for the first time this year, producing the best month of the year for bonds. A diversified bond portfolio added 2%-3% during July but is still down 10%-17% for the year, with long duration and corporate bonds performing worst.

The traditional 60/40 portfolio gained more than 5% during July but remains down 13% for the year, while the conservative 20/80 portfolio added 4% in July and is also down 13% through the first seven months of 2022.

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

Liabilities

Pension liabilities (for funding, accounting, and de-risking purposes) are driven by market interest rates. The first graph below compares our Aa GAAP spot yield curve at December 31, 2021 and July 31, 2022, and it also shows the movement in the curve last month. The second graph below shows the change in effective GAAP discount rates for pension obligations of various duration so far during 2022:

Corporate bond yields fell 0.25% during July, but rates are still 1.5% higher than at the end of 2021. As a result, pension liabilities increased 3%-4% last month but remain down 13%-19% for the year, with long duration plans seeing the largest declines.

Summary

While the first half of 2022 saw falling stocks and rising interest rates, July gave us a sharp reversal: higher stocks and lower interest rates. The net effect has been neutral to modestly positive for most pension plans this year. The graphs below show the movement of assets and liabilities during the first seven months of 2022:

Looking Ahead

Pension funding relief was signed into law last March, and additional relief was provided by November legislation. The new laws substantially relax funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors.

Discount rates moved down 0.25% last month. We expect most pension sponsors will use effective discount rates in the 4.1%-4.4% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2022, along with estimates for 2023. Pre-relief, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.

*October Three estimate, based on rates available as of 7/31/2022.