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Pension Funds Are "Compromising Their Solvency" OECD Warns
Four months ago in “The Global War On Pensioners”, we highlighted the impact perpetually suppressed risk-free rates are having on pension funds. The critical point is this: the lower the investment return assumption (the assumed discount rate), the higher the present value of pension liabilities, meaning funds must either concede that liabilities have ballooned in the low yield environment, or take greater risks to justify elevated investment return assumptions.
This state of affairs has exacerbated an already bad situation for many public sector pension funds in the US and has helped fuel a shift towards “alternatives” by funds determined to maintain investment return assumptions despite the fact that ZIRP and NIRP are making those assumptions more unrealistic by the day. For a detailed recap, see the following:
- The Global War On Pensioners
- Junk Rated Chicago Has A Billion Dollar Pension Problem
- Almost Half Of US States Are Officially Broke
- States Turn To Pension Ponzi Scheme To Close Funding Gaps
For more on the risks posed by the intersection of pension funding gaps and persistently low rates, we go to the OECD’s Business and Finance Outlook (first discussed here in the context of bond market liquidity last week):
The relationship between the liabilities of pension funds and annuity providers and the assets backing those liabilities (i.e. the funding ratio) determines the financial situation of these institutions, including their solvency. Interest rates play a role for both the asset and the liability side of the balance sheet of these institutions and understanding how interest rates affect both is essential to understanding the potential impact of low interest rates.
Low interest rates affect the liabilities of pension funds and annuity providers because the liabilities depend on the discount rate used to calculate the present value of future promises. The discount rate used to calculate the net present value is generally assumed to be the risk-free rate, usually the long-term government bond yield (e.g. the 10-year government bond yield). Other things equal, when government bond yields decline, the estimated value of future liabilities increases.
The impace of a reduction in interest rates on the value of the assets backing the liabilities of these investors depends not only on the proportion of the portfolio invested in fixed income securities, but also on the valuation methods, and the maturity of those securities.. To the extent that interest rates remain low into the future and the fixed income securities in the portfolio reach maturity, reinvestments into new fixed income securities carrying lower yields would reduce the future value of assets, in proportion with the share of the portfolio invested in fixed income securities. As a result of this lower future value of assets, pension funds' and insurance companies' assets might not be sufficient to back up their promises, unless the pension orpayment promise is adjusted to the new environment of low interest rates, low inflation, and growth..
The extent to which pension funds and insurance companies engage in a 'search for yield' is the main concern for their outlook. Pension funds may shift their portfolio allocation towards investments that could potentially fetch higher returns but in exchange for an increased overall risk profile for their investment portfolio. As pension funds move into riskier investments in search of higher returns to fulfil their pension promises, they may be seriously compromising their solvency situation in the event of a negative shock (e.g. liquidity freeze).
As you can see from the above, pension funds in the US, Canada, and the UK have moved increasingly into "other" assets over the course of the last decade.
What does the OECD define as "other" assets you ask? Here's the list: "loans, land, unallocated insurance contracts, hedge funds, private equity funds, other mutual funds, and other investments."
If that sounds risky to you, or if you have doubts about whether pensioners would knowingly stake their retirements on the performance of alternative assets that probably have no place in a conservative portfolio, just know that you're not alone. We'll leave you with the following warning from OECD Secretary General Angel Gurría:
“Pension funds and life insurers are feeling the pressure to chase yield and to pursue higher-risk investment strategies that could ultimately undermine their solvency. This not only poses financial sector risks but potentially jeopardizes the secure retirement of our citizens.”
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So glad I cashed mine out instead of taking the monthly payments. Let's see what happens now.
Another article by Captain Obvious.
Folks watching Greece think it ain't about them, when it "is" because of the pension issue. A global margin call pulls the pin on it all.
Exactly, what a bunch of fucktards. The pension funds use an average rate of return of 8% to calculate funding needs. Anyone see a problem with this math when fixed income investments are returning sub 1%? How long did the geniouses at the IMF think it would take until there just might be a problem with pension funds paying out obligations based on false assumptions? Does the IMF prefer them to raise payments from businesses struggling to breakeven from a subpar business environment or should they default on their pension obligations? Which would you prefer Mr IMF? Oh, I see, you'd rather just sit back and point out the fucking idiocy of pension fund managers attempting to get a return close to what is necessary to stay in business by going way out on the risk curve instead of looking at the root of the problem that forces them to do so! Typical fucking asshole banker.
A little George Carlin for some clarity https://youtu.be/ALlzClE67os
When nothin' ain't worth nothin'.
Insolvency is in the future for every part of our economy because of one factor: War.
https://biblicisminstitute.wordpress.com/2015/06/25/warmongering-vs-econ...
I don't have a pension and it looks like neither do they.
Government fucks wanna play hebe-o-nomics?
Here comes the slap shot fuckers. "No pension for you...
Pensions are for needy, dependent people who trust 'greater' authorities.
I heart the pensioners.
where is Merdith Whitney when u need her?
We have a massive concept problem all over the globe. We have come to believe - over the past few hundred years - that there are places where people can "put money", and "that money will grow". Attached to this concept is a corollary: "some places are safe to put money."
What's the problem with these concepts? They have become so ingrained that they have become divorced from the actual wealth production which created the background where they were possible. As long as valuable items were being manufactured, then there was something to be traded and to build accounts' value from.
But so much of the "collateral" (I use that term very loosely!) of the past 30 years has become service based that there is nothing to trade in when shit goes south.
Take software. Companies are making trillions selling intellectual capital. That's great. More power to them. But now consider the extreme example: a Carrington event that eliminates electricity from the developed world for a period of six months. In that event, what value does all that software have? It is gone. There is nothing there. Where is the "other side" of all those "trillions"?
Okay, yes, that is an extreme example. But the point can be extended to more moderate situations, where faith is lost. If some of these businesses go under simply because they cease to be "cool", it's the same question: what happened to the "money" that was created by that company? There's nothing there. The concept is entirely vaporized, but the "money" (currency, I realize, for those of you who like to point that out) is still out there.
The entire concept of "retirement savings" is based on "money growing". But what's growing? Many of the tangible goods that are being made today are disposable crap (thank you China), and much of the rest is intellectual property growth. I sure as hell wouldn't want my retirement to depend on either of those foundations.
This is the logic fail of the current FIRE sector, upon which pension funds rely. The next 300 years do not look nearly as promising as the past 300.
Good comment Papa.
This orientation will be helpful when we lose our "pensions" and "social security" for that matter. What was it built on?
Meanwhile, there are real theives out there who have really stolen from us, too. I will not lose sight of that.
Pensions will be bailed out. Retirement communities are being built which will depend on those checks as interest payments.
Here's the problem.
You can't print diesel which powers a tractors which are required to grow food.
The people who make the diesel want want something with purchasing power in return for the diesel. The diesel isn't a 'promise to pay' and any other such tom-foolery, its real stuff and they want real stuff in return for it.
You can not bail out a lie. They will default on the pensions, one way or another.
Either through paying what was promised but a loaf of bread is $600 or by being honest and simply saying, we can't pay. You get only 25% of what was promised.
Of course, since politician are involved, it will be the former, not the latter. The latter requires honesty and there's not much of that going around.
Squid
"Pension Funds Are "Compromising Their Solvency" OECD Warns"
Been there, done that, already. Why do they warn after it is already too late?
If it's a public pensions, they'll just raise taxes or borrow at outrageous interest to pay them...
"Japan Mulls Politically Dangerous Squeeze on Seniors' Benefits" http://www.bloomberg.com/news/articles/2015-06-28/japan-mulls-almost-sui...
I thought the pension funds were jeopardizing the taxpayer's solvency?