Pension Finance Update – October 2021
Pension finances gained ground in October, as resilient stock markets more than offset the impact of declining interest rates. Both model plans we track[1] improved last month: Plan A gained 2% in October and is now ahead more than 11% for the year, while the more conservative Plan B gained 1% last month and is now 3% up through the first ten months of 2021:
Assets
Stocks, led by strong US markets, bounced back after a crummy September. A diversified stock portfolio gained more than 5% last month and is now up almost 18% for the year:
Interest rates moved lower in September, producing gains of almost 1% on bond portfolios during October. For the year, bonds remain 1%-3% down for the year, with long duration bonds performing worst.
Overall, our traditional 60/40 portfolio gained 3% during October and is now up more than 8% for the year, while the conservative 20/80 portfolio gained more than 1% last month and is up 1% through the first ten months of 2021.
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 October 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:
Long-term corporate bond yields fell more than 0.10% during October, but they are still more than 0.3% higher than at the end of 2020. As a result, pension liabilities gained about 1% during the month but are still down 2%-3% for the year, with long duration plans seeing the largest declines.
Summary
Pension finances improved markedly in the first quarter of 2021 and, since then, plans have held on to most of this improvement. Stocks are on track for their third consecutive double-digit return year, which has been a huge factor in pension balance sheet improvement. The graphs below show the movement of assets and liabilities for our model plans so far during 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 moved 0.10% lower in October. We expect most pension sponsors will use effective discount rates in the 2.6%-3.0% 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.
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.
