February 2023 Pension Finance Update
Pension finances enjoyed another month of positive experience in February, as higher interest rates offset the impact of falling stock markets. Both model plans we track1 saw improvement last month: Plan A improved 2% in February and is now up almost 3% for the year, while Plan B improved a fraction of a percent last month and is up almost 1% through the first two months of 2023:
Assets
Stocks lost ground in February. A diversified stock portfolio lost close to 3% last month:
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.
Interest rates and credit spreads increased last month; Treasury yields increased 0.3% while corporate bond yields increased 0.4% during February, reversing January moves. As a result, bonds lost 2%-4% last month, but remain up about 1% for the year, with long duration Treasuries performing best so far this year.
Overall, our traditional 60/40 portfolio lost 3% during February but remains up 3% for the year, while the conservative 20/80 portfolio also lost 3% last month and is now up 1% for the year.
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, 2022 and February 28, 2023. The second graph below shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration so far this year:
Corporate bond yields rose 0.4% in January. As a result, pension liabilities fell 4%-6% during the month, with long duration plans seeing the largest declines.
Summary
February saw a reversal of January experience: lower stocks and higher interest rates. The net effect has been a modest boost for pension finances in the first two months of the year. The graphs below show the movement of assets and liabilities during the first two months of 2023:
Looking Ahead
Pension funding relief was signed into law during March of 2021, and additional relief was provided by November 2021 legislation. The new laws substantially relaxed funding requirements over the next several years, but the increase in rates seen in the past year has eroded the impact of relief.
Discount rates moved 0.4% higher last month. We expect most pension sponsors will use effective discount rates in the 4.9%-5.2% range to measure pension liabilities right now.
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2023, along with estimates for 2024. 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 2/28/2023