October 2022 Pension Finance Update
Pension finances enjoyed their best month of the year in October, driven by higher stock prices and higher interest rates. Both model plans1 we track gained ground last month; Plan A improved 6% during October and is now up 10% for the year, while the more conservative Plan B gained more than 1% last month and is now even through the first ten months of 2022:
Most stock indexes saw solid gains in October. A diversified stock portfolio gained more than 6% in October but is still down 21% so far during 2022:
For the ninth time in ten months this year, interest rates increased again in October – Treasury yields increased 0.5% while corporate bond yields increased 0.3%. As a result, bonds lost 2%-4% in October, and are now down 17%-28% for the year, with long duration and corporate bonds performing worst.
The traditional 60/40 portfolio gained 3% during October but is still down 20% for the year, while the conservative 20/80 portfolio was flat last month and remains down 21% through the first ten months quarters of 2022.
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.
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, 2021 and October 31, 2022, and it also shows the movement in the curve last month. The second graph below shows the change in effective GAAP discount rates for pension obligations of various duration so far during 2022:
Corporate bond yields rose another 0.3% during October and are now up almost 3% this year. As a result, pension liabilities fell 2%-3% last month and are now down 21%-32% for the year, with long duration plans seeing the largest declines.
Despite the worst stock market since 2008, most pension sponsors have managed to tread water or improve funded status this year due to an historic rise in interest rates. The graphs below show the movement of assets and liabilities during the first ten months of 2022:
Pension funding relief was signed into law in March 2021 and additional relief was provided by November legislation. The new laws substantially relax funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors. However, the surge in interest rates this year, if sustained, will reduce or eliminate the impact of funding relief.
Discount rates moved up 0.3% last month, reaching the highest levels seen in a decade. We expect most pension sponsors will use effective discount rates in the 5.5%-5.7% range to measure pension liabilities right now.
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2022, along with estimates for 2023. 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 10/31/2022