Pension Finance Update
Pension plans managed to tread water last month, with assets and liabilities growing about 1% each during May for both model plans we track1. Through the first five months of 2017, Plan A is ahead 2%-3%, while Plan B is up almost 1%.
Stocks were mostly up in May: the S&P 500 gained more than 1%, the NASDAQ was up more than 2% and the overseas EAFE index gained more than 3%, but the small-cap Russell 2000 dropped more than 2%. For the year, the NASDAQ is 15% ahead, the S&P 500 is up almost 9% and the EAFE index is up more than 14%. But the Russell 2000 is up just 2% in 2017 – a rough patch for the darling of 2016. C’est la vie.
A diversified stock portfolio gained 1%-2% in May and is now up 10% through the first five months of 2017.
Bonds added close to 1% in May as interest rates continued to edge down modestly. For the year, bonds are up 3%-4%, with longer duration bonds and corporates doing best.
Overall, our traditional 60/40 portfolio gained 1% in May and is now up 6%-7% for the year, while the conservative 20/80 portfolio was also up 1% last month and is now ahead 4% during 2017.
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, 2016, and May 31, 2017, and 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 2017:
The move pushed pension liabilities up 1% or so in May, leaving liabilities about 3%-5% higher during 2017, with long duration plans seeing the biggest increases.
2017 has been a strong year for stock markets so far, but lower interest rates have increased pension liabilities this year too. The combination has been a net positive for most pension sponsors this year.
The graphs below show the movement of assets and liabilities for our two model plans during 2017:
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 almost 0.1% last month. We expect most pension sponsors will use effective discount rates in the 3.6%-4.2% range to measure pension liabilities right now.
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 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.