Why Your Pension Fund Is Doomed

Tyler Durden's picture

A few days ago, when GMO released its quarterly thoughts, most focused immediately on the claim that the market is 75% overvalued. However perhaps an even more important analysis by author Ben Inker, and one which was largely ignored by most, is what front-loading so much market gains thanks to the Bernanke surge in the S&P means for future returns especially as it pertains to pension funds the bulk of which are already underfunded. GMO's conclusion was not a happy one.

If equity returns for the next hundred years were only going to be 3.5% real or so, today’s prices are about right. We would be wrong about how overvalued the U.S. stock market is, but every pension fund, foundation, and endowment – not to mention every individual saving for retirement – would be in dire straits, as every investors’ portfolio return assumptions build in far more return. Over the standard course of a 40-year working life, a savings rate that is currently assumed to lead to an accumulation of 10 times final salary would wind up 40% short of that goal if today’s valuations are the new equilibrium. Every endowment and foundation will find itself wasting away instead of maintaining itself for future generations. And the plight of public pension funds is probably not even worth calculating, as we would simply find ourselves in a world where retirement as we now know it is fundamentally unaffordable, however we pretend we may have funded it so far.

One person who read this part of Inker's paper and did do the calculation is none other than Bridgewater's Ray Dalio. His conclusion is terrifying.

The reason why public and all other pension funds are the least discussed aspect of modern finance, is that while Bernanke has done his best to plug the hole in the asset side of the ledger resulting from poor asset returns, it is nowhere near sufficient since the liabilities have been compounding throughout the financial crisis since the two grow independently. Which means that anyone who does the analysis sees a very disturbing picture.

Indeed, while the asset side can and has suffered massively as a result of the great financial crisis, the liabilities are compounding on a base that has grown steadily. As Dalio notes, each year a growing percentage of assets are paid out in the form of distributions, leaving less assets to compound at a given return.

This dynamic is shown in the chart below, which shows the change of pension fund assets over the past decade relative to the present value of liabilities discounted at a rate that has been roughly constant at around 7.5%, and rising to reflect the growth in future liabilities. Obviously, if the assets equal the value of liabilities, then the fund would be able to make its payments at a 7.5% asset return. The problem is that even with the Bernanke rally of the past five years, public pension assets are now at about the same level as in 2007 while commitments have grown. Sadly, this means that recent good returns have barely closed the gap. Needless to say, the gap grows much faster in the coming years if the future returns are less than the assumed 7.5%, something that was the basis for the GMO observations.

A key component of the pension fund calculation is the increasing portion of annual distributions less contributions as a percentage of assets. Since each year public pensions distribute about 5% of the future value of their liabilities, and these liabilities have been growing at a compounded rate of about 4%, the net cash out as a percentage of flat and/or declining assets has been progressively rising. Today, annual cash outflows amount to roughly 9% of total assets which contributions are a paltry 5% of assets, which has led to a 4% cash flow drag. This increase in net cash outflows from 1.5% of assets in 2000 to 4% most recently is shown in the second chart below.  The take home from this chart is that funds need to return 4% a year
in the near term just to avoid losing assets, and thanks to compounding,
over time the rising amount of NPVed liabilities raises the required
return even further.


That's where we stand now, but where are we headed? Assuming a 4% return and a steady growth of the liabilities means the financial gap will grow at an accelerating pace, making it more and more difficult to close the funding gap. It also means that with every passing year the required rate of return to plug the gap will grow even faster. Today, for example, the required return is 8.9%. In the future, once again assuming a 4% return on assets, means the required rate of return grows to 13% in ten years and 16% in fifteen years. Naturally, if a fund has a larger funding gap, the required return is even larger and the funding gap blows out much faster. As Bridgewater summarizes this feedback mechanism, "the dynamics of compounding cause this case machine to operate like the event horizon of a black hole: the pressures rise exponentially until it is virtually impossible to recovery."

But the scariest chart of all is the following simulation of the underfunding process over time and total fund assets held, assuming a 4% return on assets, which shows the accelerating decline in the value of asset holdings due to an increasingly negative cash flow yield, causing virtually all pension funds to run out of money. In the case of a 4% return, a pension fund that is assumed to be fully-funded today will run out of cash in 30 years; pensions that are 80% funded run out of money in 25 year, and so on. A fund with just a 20% funding ratio will have no money left in just over 5 years!

Curious what the current distribution of funds that match these criteria is? The chart below shows the percentage of current pension funds at each funding bracket. Nearly 50% of all fund are funded 80% or less.

The charts and simplistic calculations above show not only why virtually all pension funds are set for extinction in the not too distant future, but why Bernanke is stuck artificially reflating asset values if only to preserve the myth of the public pension funded welfare state. Because the biggest threat to Keynesians and monetarists everywhere is the social instability that would result once the myth of the Bismarckian welfare state unwinds.

But wait, there's more.

Bridgewater next proceeds to calculate what the economic impact is in a world in which a generous, consistent 4% return on assets is assumed. As Dalio's fund notes, in such a case the path to public pension sustainability will require some combination of benefit cuts or increased contributions to net out the liabilities and assets and close the funding gap. "Any way you cut it this will reduce someone's income, with a likely impact on their spending. Higher taxes will reduce the disposable income of workers, although the impact will be different depending on whose taxes are raised; less government spending on other things will hurt growth directly; lower benefits will reduce the disposable income of retirees who have a high propensity to spend; borrowing to finance the deficit will hurt growth less directly and over the longer term."

Bridgewater concludes that if public pensions don't delay and start plugging the hole now, they will need to contribute just under $200 billion per year over the next 30 years, amounting to 1.2% of GDP and 8.8% of state and local tax revenues. If funds wait a decade, the impact per year explodes to $325 billion over 30 years and will "cost" 1.2% of GDP and 12.2% of tax revenues. But the most likely, and worst case scenario, is if pension funds do nothing at all, "let the machine run its course", then the economic damage is unquantifiable as low asset returns inevitably cause lower income through benefits after assets are fully depleted.

And that in a nutshell is why the pension system, erected on an asset-liability mismatch gone horribly wrong, is doomed: a fact well known by the Fed chairman, and whose only countermeasure is to keep doing more of what has been done to date: inflating asset value while monetizing massive amounts of debt in the hope that the higher asset return will offset the funding gap. In principle this is great assuming the Fed can keep doing QE for the foreseeable future. However here, as everywhere else, we run into the fundamental problem with QE - the Fed is currently monetizing 0.3% of all private sector 10 Year equivalents per week, or about 15% per year. Since the Fed already holds about a third of the total, it has one, at best two years of QE left, before it is in control of an unprecedented two thirds of the entire bond market, and before the complete lack of market liquidity from central-planning gone wild, grinds Bernanke's experiment to a halt.

It is at that point that the entire flawed economic system of the past century will finally be on its last legs, as one of the core pillars of the biggest lie of all, the welfare state, resting on the flawed assumption that assets grow at a faster compounded rate than liabilities, will have no choice but to look into the abyss.

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Cognitive Dissonance's picture

The Fed wlll fix it. The Fed fixes everything. /sarc

SafelyGraze's picture


these charts are scary.

good there there is monetary inflation so that those future obligations will be more manageable to pay

bunzbunzbunz's picture

I know, I'm worthless, but if you want to get some free bitcoins just in case the skyrocket: http://freebitco.in/?r=25727

Tasty Sandwich's picture



What fraction of a bitcoin do you get for each click of that link?

knukles's picture

I been telling all my CA public employee friends about the asset liability shortfall for years.  Trying to explain ABO (which is even curtailed for CA public calcs and reporting) versus PBO, etc.
And all they say to me is that they'll raise taxes on the rich to pay for their pensions.
And they want more pension investment globally to help the poor starving kids in Kenilworth Illinios so as soon as the global meme comes up (global warming tax to pay less developed countries, etc, etc, etc) I point out on a global basis if you make $25K US, then you're in the global 1%.

Raise then taxes, cocksuckers

Fucktard Progressives.

Stuck on Zero's picture

Why contribute to pensions at all.  The system will collapse and all will be lost.  Why not give the employees what the employers would put in the pensions and then, at least, the employees would stand a chance of saving something for retirement? Bircoin retirement anyone?


NoDebt's picture

Zero- because contributions are mandatory in many cases.  One of the reasons the private sector has been gnawing off their own leg to get free of them.  Public sector... just keep promising more, knowing you'll be long gone before those promises have to be paid.

I wouldn't give a cup of warm spit for a public pension "promise" 10 years from now.  Meredith Whitney will be right.... eventually.  She was about a decade too soon with her call.

In other news:  Isn't it awesome that the government recently included pension promises in the new GDP calculation methodology?  (Posted on ZH a few months ago as part of the "intangibles" that are now included in GDP numbers).

You see that top line in the first graph?  That's now included as part of 'GDP' going forward.  The lower line?  Ignore it.  Doesn't matter.

chubbar's picture

I don't think Merideth Whitney was too early at all. If you recall, several states were within months, sometimes weeks, until a default. That was over 2 years ago. What changed in the economy or the state's finances to overcome this crisis? Nothiing. In my uninformed opinion, it is pretty obvious that the FED stepped in somehow, propped up the states and managed to get that coverage off the front page of the MSM. Probably something similar going on elsewhere. They will prop it up until it's time to let the whole thing crash but it'll be on their timeline, not individual states.

King_of_simpletons's picture

The Federal Reserve board will easily find a solution to all of this. These guys are not genius for nothing.

They will print money and voila the pension problem is gone.

michael_engineer's picture

The best pension plan may include battle axes, chain mail, long spears, and a good horse! /sarc

FreeNewEnergy's picture

Personally, I'm opting for 3 1/2 acres adjacent to a river, big fence, modest home, solar panels, dog, shotgun, lots of non-GMO seeds and healthy topsoil.

0b1knob's picture

Zero interest rate policy killed the pension fund game just like video killed the radio star.

asteroids's picture

Pension fund collapse is inevitable. But, when a large one collapses, it'll take the stock market with it. When the fund is liquidated, everything is sold, including their stawk market portfolios. The chain reaction starts here.

mkhs's picture

Not inevitable.  Just one influenza pandemic could cull many liabilities.  The magic 65-year retirement  age was conveniently chosen to be 2.5 years over life expectancy.  Who could have known life expectancy would change so much.  Damn medical science.

zaphod's picture

What is a pension? I've worked 80 hour weeks in several professional positions and never recieved one.

Ah, those are charts are for "Public Pensions", i.e. free stuff given to government workers. Welcome to the real world folks.

Kirk2NCC1701's picture

I can to better than that:  I can show you why MY pension is doomed in 1 chart.

LetThemEatRand's picture

Hey, Kirk.  Can you loan a guy a couple of bucks to make a chart?

fonzannoon's picture

If the fed has taken control of the market, and there is no disputing that they have. Why is it impossible for them to get an annual average return of say 12% for the next ten years? 

Look we are in the great shift right now. If you tune out all the noise you can see it clearly. It's weird for the CNBC's of the world because they still have airtime to fill and so they try to make it seem like there is a market. But there is no market. we say it on here all the time, but THERE IS NO MARKET.

All that is left is a wealth transfer mechanism which the fed gains control of a little more by the day. The only question left is when we can all dispense with the bullshit and just call it what it is. I think that is not too far off.


thecoloredsky's picture

right exactly. they'll hit the required return to keep pensions going but will buy less goods. i can only wait until people decide enough and en mass start converting into gold, btc, ammo, toolet paper, anything. once people stop transacting in usd its over.

tarsubil's picture

You have to pay income taxes in dollars in the US. When people start getting paid in gold or silver or something that can be reliably redeemed for a constant weight in gold and forget the income tax altogether, that will be the kicker. My guess the People and the state will go to war over that one.

"When the Lamb opened the second seal, I heard the second living creature say, "Come and see!" Then another horse came out, a fiery red one. Its rider was given power to take peace from the earth and to make men slay each other. To him was given a large sword."

NotApplicable's picture

Where "gain control" equals "hold title to everything."

Wile-E-Coyote's picture

I  stopped paying into my pension years ago. Realised it was a mugs game.

All the money printing will make pensions worthless anyway.

I have decided to take up robbing banks instead when I retire; hey they have been robbing me all my life. If I get caught at least I will get a roof over my head and three square meals per day.


Jumbotron's picture

I think with continuing inflation, at least three more BIG legs down in the continuing collapse between now and 2043,  I think that one could safely shave 5-10 years off EACH timeline in which pensions funded at various rates would go to zero.

new game's picture

i will be dead, should i care?

oddjob's picture

Somehow you'll get stripped of the right to die.

Jethro's picture

Worse than that I'm afraid. He'll start voting Democrat after he dies.

CaptainSpaulding's picture

" There are far worse things awaiting man... Than death"

   - Universial's Dracula, 1931

neidermeyer's picture

What's a pension?

Hulk's picture

Its savings with tension...

LetThemEatRand's picture

At Camp FEMA, everyone retires in style.  Obama style.  

Running On Bingo Fuel's picture

They even have a Walmart. Low prices guaranteed.


StychoKiller's picture

"Saint Peter don't ya call me 'cause I cain't go,

I owe my soul to the company store!"

knukles's picture

It's a now mythical beast which paid one enough money to live reasonably in one's older years that was supplied by a cousin of the Goose That Laid the Golden Egg, but it, too was shamelessly killed by the government and governmental employees.

What the hell.
Live like there's no tomorrow, for you're at the peak of Empire and Riches, right the fuck now.

bilejones's picture

"a fact well known by the Fed chairman, and whose only countermeasure is to keep doing more of what has been done to date: inflating asset value while monetizing massive amounts of debt in the hope that the higher asset return will offset the funding gap"


All done of course at the expense of the thrifty middle class whose real money savings could provide a base for the investment that could provide the needed growth.

walküre's picture

Californication lead by Detroitification.

"Middle class" public service sector leeches. We can do without that middle class, thank you. The producers are tapped out and refuse to pay anymore into it! Sorry! Come again!

GumbyMe's picture

Have no fear. The LAO has predicted budget surpluses for years to come, so there is enough money for everyone to live in prosperity happily ever after.

knukles's picture

LAO  Laugh Accounting Office?

RaceToTheBottom's picture

Yep, the 1% will divide and get the 99% to start shooting each other.  Equating the middle class with fat government workers is right there part of the plan.  Congrates on swallowing that hook.

Marco's picture

The capital owners will say the same to most the producers once there are no more consumers (those 2000 billionaires don't need that many servants).

piceridu's picture

"All centralized power carries the same pathology: those with the authority are never exposed to the consequences of their authority, nor do they have any responsibility for the consequences." Unknown

Bernanke will be on an island with Mr. and Mrs Krugman, Timmy, Summers and all the other psychopaths that are rewarded for being chess pieces, mouthpieces or cheerleaders for the grandest ponzi scheme of all time. We, on the other hand, will be sharing tents at Club FEMA. 

lailapa's picture

Global Debt Crisis - The greatest private fraud of human history

Who are the great fraudsters who are becoming the murderers of the human kind?

How does the economy "illness" threaten Democracy and the freedom of people?


john milton's picture

"Honey Mone

oh I am God,


she's going down, what a shame even if I have not followed the main street media, she was the one.. telling me what goes up and what goes down..

lot have changed during the years, she's still beautiful but I have gotten old, she got same waist, I got some wringles... she got her makeup artists and started to lie, I got more wringles staying honest and still was stunned by her good looks..

its like losing Marilyn.. corrupt and all.. but still going.. No one ready to admit that I do it.. Yeah, I do it, I am one of the quilty party here..

and why I did it... because she was "Forced to lie" and I was lighten enough to see it... Amerika will silently by violently vanish..

I changed to bloomberg... same gov. propaganda shit.. but hey,
who cares, stocks are making new hights and you still keep on wondering what happened, still in negative territory...

but dont worry my comrade, there surely will be new one to talk your indexies or dick up...

mvh cd
(dont know about the grammar, ask Janet Louise Yellen, 33 Liberty Street)

go and see zerohedge.com

Running On Bingo Fuel's picture

8:20p and you're this wasted?

Go easy bro.


john milton's picture

Its 03:45 over here.... am.. having some vino tinto..


john milton's picture
Member for
12 weeks 2 days
still scratching your hair and wondering why that turd put Marilyn on it..
well, keep on wondering, reading, marvellin and so light will show you the true colours...
Running On Bingo Fuel's picture

Go find something local to post your fucking dribble on, douche.


john milton's picture

sorry, it was meant to be tribute for Maria...

and you with your lousy timing for buying gold and dreaming time of kennedy is just your own fault..

you should have listened tyler...


Running On Bingo Fuel's picture

Fuck Maria man, and fuck CNBC. FED cheerleaders, all of them.