August 2022 Pension Finance Update

Pension finances were mixed during August, as higher interest rates offset the impact of falling stock markets. Both model plans1 we track were close to even last month: Plan A improved less than 1% and is now up almost 5% for the year, while the more conservative Plan B lost a fraction of 1% in August and is now down 1% through the first eight months of 2022:

Assets

All categories of stocks moved lower during August. A diversified stock portfolio lost 4% in August and is now down 18% so far during 2022:

Interest rates jumped 0.4% last month, producing negative returns for bonds. A diversified bond portfolio lost 3% during August and is now down 12%-20% for the year, with long duration and corporate bonds performing worst.

The traditional 60/40 portfolio lost 4% during August and is now down 16% for the year, while the conservative 20/80 portfolio lost 3% last month and is also down 16% through the first eight months of 2022.

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.

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 August 31, 2022, and it also shows the movement in the curve last month. The second graph below shows the change in effective GAAP discount rates for pension obligations of various duration so far during 2022:

Corporate bond yields rose 0.4% during August, ending the month at their highest level in a decade. As a result, pension liabilities fell 3%-4% last month and are now down 16%-22% for the year, with long duration plans seeing the largest declines.

Summary

2022 has been a brutal year for stock markets, but pension sponsors have been insulated from falling stock prices by higher interest rates. The net effect has been neutral to modestly positive for most pension plans this year. The graphs below show the movement of assets and liabilities during the first eight months of 2022:

Looking Ahead

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 0.4% last month, reaching the highest levels seen in a decade. We expect most pension sponsors will use effective discount rates in the 4.5%-4.8% 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 8/31/2022.