February 2017 Pension Finance Update
Pension sponsors enjoyed a second month of modest improvement in finances during February on the strength of strong stock markets. Both model pension plans we track1 gained ground again last month: Plan A improved 1% in February and is now up 2% this year, while Plan B added a fraction and is now up almost 1% total through the first two months of the year:
Stocks gained ground again in February: the S&P 500 and NASDAQ both gained almost 4%, while the small-cap Russell 2000 and overseas EAFE index were up 2%. Through two months this year, the NASDAQ is 8% ahead, the S&P 500 is up 6%, the Russell 2000 has gained more than 2%, and the EAFE index is up more than 5%.
A diversified stock portfolio gained 3% in February and is now up almost 6% through the first two months of 2017.
Bonds enjoyed a good month due to lower interest rates, adding about 1% during February. For the year, bonds are now 1%-2% ahead, on the month, with longer duration bonds and corporates doing best.
Overall, our traditional 60/40 portfolio gained more than 2% in February and is now up 3%-4% for the year, while the conservative 20/80 portfolio gained more than 1% last month and is now up 2% during 2017.
Pension liabilities (for funding, accounting, and de-risking purposes) are now driven by market interest rates. The graph on the left compares Treasury STRIPs yields at December 31, 2016, and February 28, 2017, and also shows the movement in rates last month. The graph on the right shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during 2017:
The move pushed pension liabilities up 1%-2% last month on top of a tiny increase in January. Long duration plans are seeing the biggest increases.
Two months into 2017, sponsors have enjoyed modest improvement in funded status this year.
The graphs below show the movement of assets and liabilities for our two model plans this year:
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 about 0.1% last month. We expect most pension sponsors will use effective discount rates in the 3.7%-4.3% range to measure pension liabilities right now.
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 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.