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The Economist Exposes Public Pension Illusion

Unfortunately for pensioners, reports of their retirement security have been greatly exaggerated. The Economist calculates the 10-year return on an average diversified portfolio to be a mere 2.7 percent. That’s the fourth-lowest level since 1871. This estimation comes to the chagrin of any investor, but for government pension-holders and fund managers it is much grimmer.

In nominal terms, the return on that same diversified portfolio (with a 60/40 equity to bond ratio) is close to 5 percent. Yet, when calculating their liabilities, US public pension funds use a nominal return of 7.5 percent as their discount rate. They base that figure off of long-term averages, typically of about 30 years, meaning that their expectations include the roaring returns of the early 1980s—when you needed two digits to record the average yield on Treasury bonds.

Discount rates and liabilities are inversely related, thus using a higher discount rate allows the funds to claim less liability. If this doesn’t sound bad enough already, consider that the 5 percent nominal rate is actually quite generous. Other recent, foreboding reports use a “risk-free” discount rate of 3.225 percent.

The bottom line is that by any conservative calculation US pension funds are nowhere close to covering their liabilities. As this reality becomes impossible to ignore, the government will have two choices: shift the burden onto taxpayers through increased taxes, or welch on their promised payments.

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  • Pete

    ” …the government will have two choices: shift the burden onto taxpayers through increased taxes, or welch on their promised payments.”

    This is a no-brainier …. no more in taxes.

    • Corlyss

      Would seem so to you and me. But this struggle is not nearly over. The government will fight cutting payments to its last breath. Charles Kesler has a good analysis of why this is so in his excellent I Am The Change: Barack Obama and the Crisis of Liberalism.

      Tangentially, Barone has a nice article on the Detroit paper’s reporting on its fiscal crisis.
      http://washingtonexaminer.com/how-detroit-went-broke/article/2535951

  • Jim__L

    “They base that figure off of long-term averages, typically of about 30 years, meaning that their expectations include the roaring returns of the early 1980s—when you needed two digits to record the average yield on Treasury bonds.”

    Thank you for finally making the connection between our pension fund disaster and the Fed’s loose money policies!

    Politicians and pundits have been acting for over a decade as if there were no downside to near-zero interest rates, just like they’ve been acting for decades like there’s no downside to major budget deficits.

    My generation is going to take it in the shorts because of their negligence. The fact that the Boomers are experiencing some of the drawbacks to their eternal pursuit of the Free Lunch sticks at least some of the responsibility exactly where it belongs.

  • Notjack

    I have no sympathy, none, for public employees and their unions. They have been rapping the tax payer for years.

    They get wages, benefits and pensions that are way out of line with the private sector.

    I am a part time librarian. I get 18 hours per week. No benefits, no vacation pay, no sick pay. Nothing.
    I am not allowed to work more than 19.5 hours per week.

    I would be happy to work for 20% less than what full time, unionized librarians are currently paid, with a 401K and the same insurance I had at my previous, private sector employer. But I cannot. It is a closed union shop in Fairfield County, CT.

  • cubanbob

    The issue here is that the directors of the public pension funds aren’t held personally liable for their breeches of their fiduciary duties.

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