June 2018 Pension Finance Update

June was another decent month for pension sponsors, rounding out a solid quarter and first half of 2018 for pension finance, as stock markets have eked out modest gains while higher interest rates have decreased pension liabilities. Both model plans we track1 at least held steady again last month – traditional Plan A gained 1% while the more conservative Plan B was unchanged during June. For the year, Plan A is 6% ahead, while Plan B is up 1%:

Assets

Stocks were mixed again in June: the S&P 500, NASDAQ, and small-cap Russell 2000 all gained around 1% on the month, but the overseas EAFE index dropped 3%. Through the first half of 2018, the NASDAQ is up 9%, the Russell 2000 is ahead almost 8%, the S&P 500 is up close to 3%, and the EAFE index is down almost 4%.

A diversified stock portfolio lost a fraction of 1% in June and ended the first half of 2018 up 3%.

Treasury bonds earned a fraction of 1% last month as interest rates held steady, but corporate bonds lost about 1% as yields and credit spreads increased 0.1% during June. Through the first half of 2018, a diversified bond portfolio is down 3%-4%, with long duration bonds and corporates doing worst.

Overall, our traditional 60/40 was flat during June and remains up almost 1% for the year, while the conservative 20/80 portfolio lost a fraction of 1% last month and is now down 3% through the first half of 2018.

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, 2017, and June 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 0.10% at most maturities in June, pushing pension liabilities down 1% on the month. For the year, liabilities are down 4%-6%, with long duration plans seeing the biggest drops.

Summary

Higher interest rates (corporate yields up more than 0.50% so far this year) and positive, if modest, stock market returns have combined to produce steady improvement in pension finances during the first half of 2018.

The graphs below show the movement of assets and liabilities for our two model plans so far this year:

Looking Ahead

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 0.10% last month. We expect most pension sponsors will use effective discount rates in the 3.9%-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.

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.