file photo Boyd Loving
Public pensions: The big bill
Jun 10th 2014, 16:25 by Buttonwood
STOCKMARKETS may be close to all-time highs but that hasn’t eliminated final salary pension deficits. In the corporate sector, Mercer says US schemes are just 84% funded, while in Britain, the Pension Protection Fund estimates the number at 91%. Assets may have risen, but so have liabilities, thanks to low interest rates.*
The remarkably-productive folks at the Centre for Retirement Research in Boston havererun the numbers for state and local pension schemes. They find that the average scheme is just 72% funded, despite buoyant equity markets in 2013; back in 2001, the average scheme was 103% funded. On the plus side, the ratio may go up a bit. Up until last year, asset prices were smoothed over five years, which means 2009 is still dragging down the numbers; as it drops out, the funding ratio may rise.
But that is small comfort, because the liabilities are calculated by discounting future pension promises at the assumed rate of return, currently 7.7%. Even if one accepted the argument that this is the right way to discount a bill (the riskier your portfolio, the lower your pension bill appears to be, so the problem disappears if you put all your money in Venezuelan bonds), this seems a bit odd. In a world where 10-year treasuries yield 2.6%, 7.7% is a stretch.
The CRR calculates that the pension shortfall, on the states’ assumptions, is $1.1 trillion. A more realistic 5% discount rate pushes that up to $3 trillion, and 4% would make it $3.8 trillion. One could, of course, use a Treasury bond yield as the discount rate on the grounds that the liabilities are guaranteed but as the CRR has shown elsewhere, that doesn’t seem to be the case; states have been cutting benefits, mainly though skimping on inflation-linking.
Assuming too high a return eventually catches up with you. Returns fall short of assumptions so the deficit grows, and schemes must put in more money. The CRR shows that the required contribution rate has more than doubled from 6.7% of payroll in 2001 to 17.6% this year. Even then, the average state is only paying around four-fifths of the required rate sot the bill is merely being postponed.
https://www.economist.com/blogs/buttonwood/2014/06/public-pensions?fsrc=scn/tw/te/bl/thebigbill
