Pension Finance Update July 2024

Pension sponsors suffered their first monthly setback this year in July, as lower interest rates pushed up liabilities. Both model plans we track [1] lost ground last month: Plan A lost almost 1% but remains up 8% this year through July, while Plan B lost a fraction of 1% last month but remains up almost 2% through the first seven 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 July. A diversified stock portfolio gained more than 2% last month and is now up 13% for the year through July, with US large cap and tech stocks leading the way:

Interest rates fell 0.2% during July while credit spreads tightened modestly. As a result, bonds gained 2%-3% during July, ending the month down 2% to up 1% for the year, with long duration bonds performing worst.

Overall, our traditional 60/40 portfolio gained 2% last month and is now up more than 7% for the year, while the conservative 20/80 portfolio also gained 2% last month, ending July up 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, 2023 and July 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 July but remain up 0.25% for the year. As a result, pension liabilities rose 2%-3% last month and are now down 1% to up 2% for the year through July, with long duration plans enjoying the best experience.

Summary

Lower interest rates over the past few months have offset continued stock market gains, but 2024 is still looking like another good year for pension sponsors so far. The graphs below show the movement of assets and liabilities during the first seven 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 moved lower last month. We expect most pension sponsors will use effective discount rates in the 5.0%-5.3% range to measure pension liabilities 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.