May 2021 Pension Finance Update

Pensions saw a second consecutive flat month in May, as both assets and liabilities grew about 1%. Both model plans we track[1] continued to tread water last month. Through the first five months of 2021, Plan A is up more than 11% while the more conservative Plan B has improved 3%:

Assets

Stocks were mixed last month. A diversified stock portfolio gained 1% in May and is now up more than 11% for the year:

Interest rates were a smidgen lower in May while credit spreads continued to narrow, reaching their tightest level in almost 25 years. As a result, bonds gained almost 1% last month but remain down 3%-6% for the year, with long duration bonds performing worst.

Overall, our traditional 60/40 portfolio gained less than 1% during May and is now up almost 5% for the year, while the conservative 20/80 portfolio also gained less than 1% in May and is now down less than 2% 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, 2020 and May 31, 2021, 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 2021 so far:

Corporate bond yields slipped about 0.05% in May, but they remain up 0.50% since the end of 2020. As a result, pension liabilities rose almost 1% during the month but remain down 4%-8% for the year, with long duration plans seeing the largest declines.

Summary

Through May, pension sponsors have managed to hang on to the gains they saw in the first quarter of the year. The graphs below show the movement of assets and liabilities for our model plans during the first five months of 2021: 

Looking Ahead

Pension funding relief was signed into law during March. The new law substantially relaxes funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors.

Discount rates edged lower last month. We expect most pension sponsors will use effective discount rates in the 2.7%-3.2% range to measure pension liabilities right now.

The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2021, along with estimates for 2022, reflecting the new law (ARPA). 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.