Pension Finance Update August 2024

Pension finances slipped modestly in August, as lower interest rates pushed up liabilities. Both model plans we track[1] lost ground last month: Plan A lost 1% but remains up 7% this year through August, while Plan B lost a fraction of 1% last month but remains up more than 1% through the first eight months of 2024:

[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.

Assets

Stocks were mixed during August. A diversified stock portfolio gained more than 1% last month and is now up 15% for the year through August, with US large cap and tech stocks leading the way:

Interest rates fell 0.2% during August. As a result, bonds gained 2% during August, ending the month flat to up 3% for the year, with long duration bonds performing worst.

Overall, our traditional 60/40 portfolio gained more than 1%% last month and is now up 9% for the year, while the conservative 20/80 portfolio gained 2% last month, ending August up 4% for the year.

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, 2023 and August 31, 2024 (along with 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 2024:

Corporate bond yields fell 0.2% in August but remain slightly above rates at the end of 2023. As a result, pension liabilities rose 2%-3% last month and are now up 1%-3% for the year through August, with long duration plans enjoying the best experience.

Summary

Interest rates spiked in early 2024, boosting pension finances, but rates have moved lower since April, producing pension headwinds over the past four months. Meanwhile, stocks are enjoying another strong year through August. The net impact is continued improvement in pension finances this year. The graphs below show the movement of assets and liabilities during the first eight months of 2024:

Looking Ahead

Sustained higher interest rates since late 2022 have (for now) effectively ended pension funding relief that has been in place since 2012. Underfunded plans are likely to see sharp increases in required contributions in the next year or two.

Discount rates for corporate financial reporting moved lower last month. We expect most pension sponsors will use effective discount rates in the 4.8%-5.1% range to measure pension liabilities on their balance sheets right now.

The table below summarizes rates that calendar-year plan sponsors are required to use for IRS funding purposes for 2024, along with estimates for 2025. Pre-relief, both 24-month averages and December ‘spot’ rates, are also included.