Monday, February 4, 2013

How are public pension funds like Aesop's grasshopper?

Low interest rates are leading to low investment returns, which is causing private pensions to save more.  Formally, the official discount rate has been reduced from about 5% to 4% which means that the discounted pension liabilities facing companies are a lot bigger, so they save more.  Here is what happened to Ford:

...falling interest rates in the U.S. and Europe, where Ford has had operations in England for 100 years, erased its gains. Ford's pension plans had strong real-world returns—up more than 14%. But the company had to lower its discount rate to 3.84% from 4.6%, which created a bigger liability on its balance sheet.

Ford, intent on hitting a goal of getting to a fully-funded pension by mid-decade, is committing to spend $5 billion on its pensions this year. It is using $1.2 billion in borrowed funds to pay into the accounts, as well as cash on hand.

GM, Verizon, ATT, Boeing, Dow are all facing losses due to increases in pension liabilities caused by the lower discount rates.  In contrast, public pensions are still discounting future liabilities at about 7.5%-8%.  This makes the future liabilities look much smaller, so cities and states can spend more.  Of course when the future finally gets here, things are going to be bad. 

This insight is not new.  Aesop recognized the importance of using low discount rates in his classic fable "The Ant and the Grasshopper." 

1 comment:

  1. If you please tell us something on pension types and pension investment rates etc?