October 2017 Pension Finance Update
The big story for pension sponsors in 2017 so far is the remarkably steady increases in stocks, which have gained ground every month this year, overcoming interest rates that continue to flirt with historic lows. October saw a continuation of this pattern, improving the funded status for both model plans we track1. Traditional Plan A improved 1% last month and is now up more than 4% for the year, while the more conservative Plan B improved a fraction of 1% in October and is now ahead 1%-2% through the first ten months of 2017.
Assets
Stocks continued to chug along in October: the S&P 500 gained more than 2% last month, the NASDAQ jumped more than 3%, the small-cap Russell 2000 added 1%, and the overseas EAFE index was up 2%. Through October, the Russell 2000 is ahead 12%, the S&P 500 is up 17%, the EAFE has gained 22%, and the NASDAQ has earned 25%.
A diversified stock portfolio gained more than 2% during October and is now up 19% through the first ten months of 2017.
Treasury bonds slipped a fraction of 1% during October while corporate bonds gained about 1%, as credit spreads narrowed to their tightest level in 3-1/2 years. A diversified bond portfolio gained less than 1% last month and has earned 4%-7% so far during 2017, with longer duration bonds and corporates doing best.
Overall, our traditional 60/40 portfolio gained 1%-2% in October and is now up almost 12% for the year, while the conservative 20/80 portfolio added 1% last month and is now more than 7% ahead during 2017.
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, 2016, and October 31, 2017, 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 durations during 2017:
The yield curve flattened a bit in October, increasing 0.1% at the short end while declining 0.1% at the long end.
The move pushed pension liabilities up about 1% in October, leaving liabilities 6%-8% higher during 2017, with long duration plans seeing the biggest increases.
Summary
With only two months to go in 2017, pension sponsors are enjoying improvement in pension funded status this year, with asset growth outpacing liability growth for most plans.
The graphs below show the movement of assets and liabilities for our two model plans during the first ten months of 2017:
Looking Ahead
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 a couple basis points last month. We expect most pension sponsors will use effective discount rates in the 3.6%-4.0% 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.
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.