September 2019 Pension Finance Update

Both stocks and interest rates moved higher in September, helping plans partially recover from an awful August. Both model plans we track[1] gained ground last month: Plan A improved 2% last month but remains down almost 5% for the year, while Plan B gained less than 1% and remains down 1% through the first three quarters of 2019:

Assets

Stocks gained ground in September and continue to boast solid returns through the first three quarters of 2019:

Interest rates moved up about 0.15% in September, translating to losses on bonds of 1% during the month. For the year, bonds have earned 12%-15%, with long duration and corporate bonds performing best.

Overall, our traditional 60/40 portfolio was up less than 1% during September and is now up 14% so far this year, while the conservative 20/80 portfolio lost less than 1% last month and is also up 14% through the first three quarters of 2019.

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, 2018 and September 30, 2019, 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 2019:

Corporate bond yields rose more than 0.1% in September – the first meaningful upward move this year – providing some relief to pension sponsors. Pension liabilities fell 1%-2% in September but remain up 14%-23% for the year, with long duration plans seeing the largest increases.

Summary

Through the first three quarters of 2019, pension sponsors have seen strong asset growth but even stronger liability growth, as interest rates continue to flirt with all-time lows. The graphs below show the progress of assets and liabilities for our two model plans through September this year: 

Looking Ahead

Pension funding relief has reduced required plan funding since 2012, but under current law, this relief will gradually sunset. Given the current level of market interest rates, it is possible that relief reduces the funding burden through 2028, but the rates used to measure liabilities will move significantly lower over the next few years, increasing funding requirements for pension sponsors that have only made required contributions. 

Discount rates rose about 0.1% last month, moving up from all-time low levels. We expect most pension sponsors will use effective discount rates in the 2.9%-3.3% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2019, along with estimates for 2020. Pre-relief, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.

[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.