October 2019 Pension Finance Update

Pension finances improved in October on the back of continued strong stock markets. Both model plans we track[1] gained ground last month: Plan A improved more than 1% in October but remains down more than 3% for the year, while Plan B gained less than 1% and is now close to flat through the first ten months of 2019:

Assets

Stocks enjoyed another solid 3% return in October and have now earned 20% during 2019:

Treasury rates moved up a couple basis points during October while corporate bond yields were essentially flat, producing returns of less than 1% on bonds during the month. For the year, bonds have earned 12%-16%, with long duration and corporate bonds performing best.

Overall, our traditional 60/40 portfolio was up almost 2% during October and is now up 16% so far this year, while the conservative 20/80 portfolio gained less than 1% last month and is up 15% through the first ten months of 2019.

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, 2018 and October 31, 2019, and it also shows the (lack of) movement in the curve last month. The second graph below shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during 2019:

Corporate bond yields were basically flat during October. As a result, pension liabilities rose less than 1% for the month and are now up 15%-24% for the year, with long duration plans seeing the largest increases.

Summary

Pension sponsors continue to suffer from interest rates near record lows, but strong stock markets this year have offset much, but not all, of the pain of higher liabilities. The graphs below show the progress of assets and liabilities for our two model plans through October this year: 

Looking Ahead

Pension funding relief has reduced required plan funding since 2012, but under current law, this relief will gradually sunset. Given the current level of market interest rates, it is possible that relief reduces the funding burden through 2028, but the rates used to measure liabilities will move significantly lower over the next few years, increasing funding requirements for pension sponsors that have only made required contributions. 

Discount rates were flat. We expect most pension sponsors will use effective discount rates in the 2.9%-3.3% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2019, along with estimates for 2020. 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 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.