Pension finances deteriorated slightly in March, and both ‘model’ plans we track[1] ended the first quarter of 2014 in modestly negative territory. Traditional ‘Plan A’ lost about 1% last month and is now down almost 4% for the year, and ‘Plan B’ slid less than 1% during March, ending the quarter almost 2% in the red.
Assets
Stocks were mixed during March, with the S&P 500 gaining 1% while the NASDAQ dropped more than 2%, the small-cap-Russell 2000 fell by less than 1% and the overseas EAFE index was down a fraction of 1%. Through the end of the first quarter of 2014, S&P 500 is ahead almost 2%, the NASDAQ is up less than 1%, and the Russell 2000 and EAFE index have both earned about 1%.
For the month, a diversified stock portfolio lost less than 1%. Year-to-date, stocks have earned about 1%.
Interest rates were also mixed, with medium-term rates edging up while long-term rates declined a bit. Modest flattening of the yield curve produced small losses (less than 1%) on medium-term bonds and small gains (also less than 1%) on longer-dated bonds. So far in 2014, both Treasury and corporate bonds have earned 2%-3%, with long duration bonds faring best.
Overall, our traditional 60/40 portfolio lost a fraction of 1% last month, but is still 1%-2% ahead for the year, while a conservative 20/80 portfolio was flat during March and remains up 2%-3% through the first quarter of 2014.
Liabilities
Both funding and accounting liabilities are now driven by market interest rates. The graph below compares Treasury STRIPs yields at December 31, 2013, and March 31, 2014:
As mentioned above, the yield curve flattened a bit during March, with rates in the 5-10 year range rising about 0.1%, while rates at 20-30 years fell by 0.05%. At the close of the first quarter, rates are basically unchanged in years 1-5 and down about 0.4% at the long end of the curve. Credit spreads have been stable, so we are seeing similar behavior among corporate bond yields. The upshot is that pension liabilities increased less than 1% during March and remain about 4%-5% higher than at the end of 2013, with long-duration plans seeing the biggest increases.
Summary
After the strong performance of 2013, a pullback in the first quarter of 2014 is not overly surprising, but plans remain in far better shape than a year ago. Our traditional Plan A has seen decline of almost 4% in funded status through March, while the (more conservative) Plan B is down almost 2%. The graphs below track the movement of assets and liabilities for our two model plans during the first quarter of 2014:
Looking Ahead
As we discuss in our 2013 article MAP-21 and DB plan finance – Looking ahead to 2014, pension funding requirements over the next few years will not be significantly affected by changes in interest rates. So, from a cash perspective, required contributions for 2014 and 2015 will not be much affected by rate fluctuations.
After climbing about 1% in 2013, rates have moved back down in early 2014. Rates remain low by historical standards, with most sponsors using rates below 5% to measure pension liabilities for accounting purposes.
The graph below charts the movement of PPA “2nd and 3rd segment rates” since December 2011. While these rates don’t strictly meet GAAP measurement requirements, we think they are a very good resource for understanding “rule of thumb” discount rates for plans:
The table below summarizes rates that plan sponsors are required to use for IRS funding purposes for 2014, along with estimates for 2015. Pre-MAP-21 rates, both 24-month averages and December ‘spot’ rates, which are still required for some calculations, such as PBGC premiums, are also included.
October Three, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.
Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.
[1] Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds. For both plans, we assume the plan is 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.
