Stocks tumbled again in June, driving the worst month of the year for pension finance. Both model plans1 we track lost ground last month: Plan A lost more than 3% but remains up 2% for the year, while the more conservative Plan B lost 1%, ending the first half of 2022 down 1%:
Stocks fell more than 8% in June. A diversified stock portfolio lost more than 20% in the first half of 2022, the worst first half for stock markets since 1970:
Interest rates moved higher again in June. During the first half of 2022, Treasury rates increased 1.25% while corporate bond yields rose 1.75%. As a result, bonds lost more than 1% during June and ended the first half of 2022 down 11%-20%, with long duration and corporate bonds performing worst.
The traditional 60/40 portfolio lost more than 5% during June and 18% during the first half of 2022, while the conservative 20/80 portfolio lost 3% in June and 16% for the year through June.
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 June 30, 2022, and it also shows the movement in the curve last month. The second graph below shows the increase in effective GAAP discount rates for pension obligations of various duration so far during 2022:
Corporate bond yields increased 0.25% during June, ending the first half of 2022 up an astonishing 1.75%. As a result, pension liabilities decreased 2%-3% last month and are now down 15%-23% for the year, with long duration plans seeing the largest declines.
Pension balance sheets shrank by close to 20% in the first half of 2022, but most pension sponsors have managed to at least tread water so far this year, as sharply higher interest rates have neutralized the impact of falling stock markets. The graphs below show the movement of assets and liabilities during the first half of 2022:
Pension funding relief was signed into law last March, 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.
Discount rates moved up 0.25% last month. We expect most pension sponsors will use effective discount rates in the 4.4%-4.7% 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 6/30/2022.