Pension finances improved in August due to strong stock markets and modestly higher interest rates. Both model plans we track gained ground last month: Plan A improved close to 2% in August and is now up almost 11% for the year, while the more conservative Plan B gained a fraction of 1% last month and is now up almost 3% through the first eight months of the year:
All varieties of stocks were up in August. A diversified stock portfolio earned 2%-3% last month and is now up more than 16% for the year:
Interest rates edged higher last month, producing losses of less than 1% on bond portfolios during August. Bonds remain down 1%-2% for the year, with long duration bonds performing worst.
Overall, our traditional 60/40 portfolio gained more than 1% during August and is now up more than 8% for the year, while the conservative 20/80 portfolio gained a fraction of 1% last month and is now up more than 1% through the first eight months of 2021.
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 August 31, 2021, and it also shows the movement in the curve last month. The second graph below shows our estimate of movements in effective GAAP discount rates for pension obligations of various duration during 2021 so far:
Corporate bond yields moved a few basis points higher during August and are now up more than 0.25% since the end of 2020. As a result, pension liabilities fell less than 1% during the month and remain down 1%-2% for the year, with long duration plans seeing the largest declines.
Pensions enjoyed a great first quarter this year, before giving back some early year gains during April-July, but August delivered a nice bounce back for pension finance, which is on track for its best year since 2013. The graphs below show the movement of assets and liabilities for our model plans so far during 2021:
Pension funding relief was signed into law during March. The new law substantially relaxes funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors.
Discount rates edged up a few basis points in August. We expect most pension sponsors will use effective discount rates in the 2.5%-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, reflecting the new law (ARPA). 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.