Higher interest rates gave pension finance a boost in January. Both model plans we track gained ground last month, with Plan A improving 2% while the more conservative Plan B gained less than 1%:
Stock indexes were mixed in January, with the small cap Russell 2000 posting the top monthly return (only a fraction of which is likely due to GameStop). A diversified stock portfolio gained less than 1% last month:
Interest rates rose almost 0.2% in January while credit spreads narrowed by a couple basis points. 0.4% in January and corporate bond yields fell more than 0.25% on rising credit spreads. As a result, bonds lost 1%-2% last month, with long duration bonds performing worst.
Overall, our traditional 60/40 portfolio lost a fraction of 1% during January, while the conservative 20/80 portfolio lost more than 1%.
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, 2020 and January 31, 2021. The second graph below shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during January:
Corporate bond yields moved up almost 0.2% in January. As a result, pension liabilities fell 2%-3% during the month, with long duration plans seeing the largest declines.
After spending most of 2020 underwater, pension finance got off on the right foot in 2021, thanks to higher interest rates. The graphs below show the movement of assets and liabilities during January 2021:
Pension funding relief has reduced required plan funding since 2012, but under current law, liabilities will increase substantially for 2021-2023. Plans that have only made required contributions in the past can expect significant increases in required contributions over the next couple years.
However, during January, Congress introduced pension funding legislation that would extend relief for several more years. The progress of this legislation will be crucial to pension decision-making in the months ahead.
Discount rates moved higher last month. We expect most pension sponsors will use effective discount rates in the 2.4%-2.9% range to measure pension liabilities right now.
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2021, along with estimates for 2022. Pre-relief, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.
 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.