May 2022 Pension Finance Update
Financial markets continued to roil in May, but the net impact on pension finance was modest. Both model plans1 we track were close to even on the month. Through the first five months of 2022, Plan A remains up 4%-5% while the more conservative Plan B is holding at even on the year:
Stocks were mixed in May. A diversified stock portfolio added a fraction of 1% in May but is still down almost 14% year-to-date:
Treasury rates edged higher for the 5th consecutive month this year, producing continued headwinds for bonds. Returns during May were flat, leaving bonds down 9%-16% for the year, with long duration and corporate bonds performing worst.
Both the traditional 60/40 portfolio and the conservative 20/80 portfolio were flat during May and remain down 13% through the first five 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.
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 May 31, 2022, and it also shows the (small) movement in the curve last month. The second graph below shows the increase in effective GAAP discount rates for pension obligations of various duration so far during 2022:
Corporate bond yields were flat during May and remain up 1.4% for the year. As a result, pension liabilities were flat during May and remain down 13%-19% for the year, with long duration plans seeing the largest declines.
Higher interest rates and declining stock markets have shrunk pension balance sheets this year, with most sponsors maintaining or improving their funded stats so far this year. The graphs below show the movement of assets and liabilities during the first five months of 2022:
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 were flat last month. We expect most pension sponsors will use effective discount rates in the 4.0%-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 5/31/2022.