April 2018 Pension Finance Update

Higher interest rates boosted pension finances in April. Both model pension plans we track1 gained ground last month – traditional Plan A gained more than 1% in April while the more conservative Plan B improved less than 1%. For the year, Plan A is now 4%-5% ahead, while Plan B is up almost 1%:

Assets

Stocks were marginally higher in April: the S&P 500 and NASDAQ each gained a fraction of 1%, while the small-cap Russell 2000 added 1% and the overseas EAFE index increased almost 2%. Through April, the NASDAQ is up more than 2%, the EAFE index is up more than 1%, the Russell 2000 is up almost 1%, and the S&P 500 is down less than 1% for the year so far.

A diversified stock portfolio gained less than 1% in April and is up about 1% for the year.

Bonds lost 1%-2% during April, as interest rates rose by 0.15% during the month. For the year, a diversified bond portfolio is down 3%-4% for the year so far.

Overall, our traditional 60/40 was flat during April and remains down 1% for the year, while the conservative 20/80 portfolio lost 1% and is now down 3% after the first four months of 2018.

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, 2017, and April 30, 2018, 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 duration during 2018:

Corporate bond yields rose 0.15% at most maturities in April, pushing pension liabilities down 1%-2% on the month. For the year, liabilities are down 4%-5% – a bit less for short duration plans, a bit more for long duration plans.

Summary

Interest rates have risen more than 0.50% so far this year, while stock markets have held steady, producing good news for pension sponsors so far in 2018 in the form of lower pension liabilities.

The graphs below show the movement of assets and liabilities for our two model plans so far this year:

Looking Ahead

Congress passed a budget in 2015 that includes a third round of pension funding relief since 2012. The persistence of historically low interest rates, however, means that pension sponsors that have only made required contributions will see contributions ramp up in the next few years as the impact of relief fades (barring an increase in long-term rates).

Discount rates fell 0.1% last month. We expect most pension sponsors will use effective discount rates in the 3.9%-4.4% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2018, along with estimates for 2019. 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.