July Signals Positive Trend for Pension Plan Sponsors

According to the “Pension Finance Update” from retirement plan services firm October Three LLC, “Led by a strong stock market performance, July added to an outstanding first half for pension sponsors in 2013. The two model plans we track both saw improvements in funded status last month.”

The model plans are a traditional ‘Plan A,’ which was up 3% for July and is now 16% ahead year-to-date, while the more conservative ‘Plan B’ improved 1% last month and is up 4% for the year. 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, October Three assumes the plan is 100% funded at the beginning of the year and ignores benefit accruals, contributions, and benefit payments in order to isolate the financial performance of plan assets versus liabilities.

The firm said stocks rebounded from a down month in June, posting solid gains across the board in July. The S&P 500 gained 5%, NASDAQ was up more than 6%, the small cap Russell 2000 added 7%, and the overseas EAFE was ahead more than 5%. Year-to-date, the S&P 500 and NASDAQ were both up 20%, the Russell 2000 was ahead 22%, and the EAFE index gained 9%. A diversified stock portfolio added 5% to 6% during July and was up 18% so far this year.

Treasury rates rose again last month, up 0.10% to 0.15%, but corporate bond yields edged up only a couple basis points in July. As a result, Treasury bonds lost about 1% and corporates gained a fraction of 1%. Year-to-date, bonds remain underwater due to higher interest rates this year. A diversified bond portfolio was down 3% to 5% so far in 2013. Long duration bonds, which are more sensitive to interest rate movements, continue to perform worse this year.

Overall, July was found to be a good month for investments. October Three’s traditional 60/40 portfolio gained more than 3% and was up 9% so far during 2013, while a 20/80 portfolio gained 1% in July but remained down 1% so far this year.

With regard to both funding and accounting liabilities, the analysis found that with the increase during July, Treasury rates now stand 0.75% higher than at the end of 2012. The same was found to be true for corporate bond yields, which didn’t move much in July but were already up 0.75% through June. Credit spreads on high quality corporates are lower than 1.5% and were found to be in line with pre-2008 financial crisis levels. Pension liabilities rose less than 1% in July but remained 4% to 6% lower than at the end of 2012.

In summary, the analysis by October Three, found higher stock markets and higher interest rates were both good news for pension plan sponsors. So far, 2013 has delivered on both counts. However, the firm cautioned that “the economy can falter and the markets can retrace their steps with 2010, 2011, and 2012 all following a pattern of early promise that ultimately fizzled.”

The Chicago-based October Three, LLC is an actuarial, consulting and technology firm that works with defined benefit retirement plans. More information is at http://www.octoberthree.com.