Tuesday, August 30, 2016

Chart of the Day: Pension Assumptions & Collective Blindness

Pensions look like a slow motion car crash across the US and Western Europe. The data is clear, we are living longer, there are more older people to support, bond yields are falling and pension liabilities are rising.

However, pensions are about long term decision making and politicians are keen to defer the hard decisions if they can. Let's take US public pensions.

What return are you expecting on your saving and investments? 3%, 4%, 5%?

US public pensions plans currently assume an average 7.6 per cent rate of return, according to the National Association of State Retirement Administrators. The Financial Times has provided a chart which shows the differences between assumptions and the reality of current yields.



Why don't States like Illinois make more realistic assumptions about returns?  In simple terms lower assumptions will require higher pensions contributions. It would mean that the State has to increase taxes or cut services to fund these liabilities. The FT quotes various experts who believe that lower assumptions would require over $100bn in increased contributions.

There is no immediate benefit to politicians in lowering assumptions but there is a political cost in higher taxes and reduced services. Thus there is a collective blindness and willingness to assume that returns will improve at some point in the future making higher contributions unnecessary. 

No one will be able to say we didn't see this crisis coming.