August 2017 Pension Finance Update

Pension funded status slipped in August, due to flat stock markets and remorselessly lower long-term interest rates. Both model plans we track1 saw modest declines last month – traditional Plan A dropped more than 1% but is still up 1% for the year, while the more conservative Plan B lost less than 1% in August but also remains 1% ahead so far in 2017.

Assets

Stocks were mixed during August: the NASDAQ gained 1%, but the S&P 500 and overseas EAFE index were flat, while the small-cap Russell 2000 lost more than 1%. For the year, the NASDAQ has gained 19%, the S&P 500 is up 12%, the Russell 2000 is ahead 4%, and the EAFE has earned 17%.

A diversified stock portfolio was flat during August and remains up 13% through the first eight months of 2017.

Bonds gained 1%-2% during August as interest rates again moved lower. A diversified bond portfolio has earned 5%-6% so far during 2017, with longer duration bonds and corporates doing best.

Overall, our traditional 60/40 portfolio gained less than 1% in August and is now up more than 9% for the year, while the conservative 20/80 portfolio was up 1% last month and is now 7% ahead during 2017.

Liabilities

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, 2016, and August 31, 2017, and it also shows the movement in the curve last month. The graph on the right shows our estimate of movements in effective GAAP discount rates for pension obligations of various durations during 2017:

Yields moved down another 0.1% during August and are now about 0.4% lower than where they ended 2016 and less than 0.25% higher than the all-time lows seen in July 2016.

The move pushed pension liabilities up 1%-2% in August, leaving liabilities about 6%-9% higher during 2017, with long duration plans seeing the biggest increases.

Summary

Strong stock markets and lower interest rates have propelled pension assets higher during 2017, but lower rates have also increased liabilities. Through August, plans remain modestly ahead so far during 2017.

The graphs below show the movement of assets and liabilities for our two model plans during the first seven months of 2017:

Looking Ahead

Congress passed a budget in 2015 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 a couple basis points last month. We expect most pension sponsors will use effective discount rates in the 3.4%-4.0% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2017, along with estimates for 2018. 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.