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September was another month of modest improvement in pension finance, due to higher interest rates. Our traditional Plan A[1] improved for the sixth straight month – up less than 1% in September and now ahead almost 9% for the year, while the more conservative Plan B was flat last month but remains up almost 2% year-to-date:
Stock returns were mixed in September: the S&P 500 gained less than 1%, NASDAQ lost almost 1%, the small-cap Russell 2000 declined more than 2%, and the overseas EAFE index added 1%. Through the first three quarters of 2018, the S&P 500 is ahead almost 11%, NASDAQ is up more than 16%, and the Russell 2000 has gained more than 11%, while the EAFE index has lost 2%.
A diversified stock portfolio was flat in September and remains up almost 9% for the year.
Bonds lost about 1% during September, as interest rates rose, and credit spreads narrowed. Through September, a diversified bond portfolio is now down 3%-4%, with long duration bonds and corporates doing worst.
Overall, our traditional 60/40 lost less than 1% in September and remains up 3% for the year, while the conservative 20/80 portfolio also lost less than 1% last month and is now down 2% through the first three quarters of 2018.
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 September 30, 2018, 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 duration during 2018:
Corporate bond yields rose more than 0.10% during September, pushing pension liabilities down almost 1%. For the year, liabilities remain down 4%-6%, with long duration plans seeing the biggest drops.
2018 has been a year of grinding improvement for pension sponsors. The ability of stocks to maintain valuations and even continue to rise in the face of increasing interest rates has quietly produced significant improvement in pension finance in the first three quarters of 2018.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).
Discount rates rose 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 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.
[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.