Pension plan sponsors disclose financial results on a fiscal-year basis, which in most cases is the end of the calendar year. Choosing one day to measure the position of corporate plans over the course of the year is somewhat arbitrary, in that if not for the financial disclosures, any other day throughout the year might be as appropriate as another. What gets reported is a snapshot at a single point in time, regardless of what has happened in between measurement dates.
What happened in between the start and end of 2020 is actually quite interesting. Had the ending point for the liability calculation been another arbitrary point in time, we’d be reading something entirely different in those financial statements. Let’s have a closer look.
What did liabilities face in 2020?
Pension liabilities move with changes in discount yields, which consist of interest rates and a credit spread. When corporations disclose liabilities in their financial statements, they show the net impact accumulated over the course of a year of changes in those components. It’s common for interest rates and credit spreads to move in opposite directions, and that’s what happens when viewing end-of-year snapshots compared with beginning-of-year snapshots. A generic liability of duration at approximately 12 will have increased around 10% from beginning to end, since interest rates decreased substantially but were offset by a slight widening in credit spreads.
March was especially interesting thanks to the volatility that COVID-19 created. Treasury yields hit their lowest point for the year around March 9, which resulted in a temporary peak in the value of our illustrative liability: 20% higher than at the beginning of the year. Credit spreads then continued to widen rapidly in the following days, peaking on March 20, which resulted in a temporary valley in liability values: 18% lower than at the beginning of the year, nearly a 40% difference between peak and trough. Remarkably the liability value on March 30 was essentially back to the level seen at the beginning of the year. But this wasn’t because everything was back to normal; it just happened to be a point where much lower Treasury rates were offset by much higher credit spreads.
From the end of March until early August, liabilities steadily climbed as Treasury rates remained locked in a narrow range, and credit spreads steadily tightened. The remainder of the year left pension plans with relatively stable liabilities, with slight increases in Treasury yields usually being offset by narrowing credit spreads. In summary, liabilities increased over the course of the year, and there was a period of extreme volatility between the endpoints.
Illustrative liability in 2020
Source: Parametric, 12/31/2020. For illustrative purposes only. Illustrative example does not represent the liability attributes of an actual client of Parametric.
Treasury zero-coupon yields
Sources: Parametric, ICE BofA, 12/31/2020. For illustrative purposes only.
AA spreads over Treasury zero-coupon yields
Sources: Parametric, ICE BofA, 12/31/2020. For illustrative purposes only. Not a recommendation to buy or sell any security.