Bloomberg points out here that a decade of ultra-low interest rates is not helping public pension funds. Low rates increase the projected liabilities of pension plans. Low rates also make retirement much more expensive which drives up savings and helps to dampen the intended impact of providing monetary stimulus in the first place. What will pension funds do if the next big bear market occurs before rates are normalized?
A woefully under-reported side effect of perpetually easy money is the impact on the pension industry. We’ve looked at this issue in the past, and unfortunately the news hasn’t gotten any better. With 2019 in the books, the Milliman corporate pension index showed a tasty 15.7% annual return on assets. Unfortunately, funding ratios didn’t improve one iota, as the sharp decline in yields raised the NPV of plan liabilities; in fact, funding ratios even dipped slightly despite the sharp rise in equities.
Great equity returns in 2019 didn’t help pension funding ratios
The news isn’t much better on the public pension side, despite their higher allocation to equities. Milliman estimates that through the middle of last year, public pension funding ratios only increased to 73.4% from the 72.8% reported in mid-2018. That’s only slightly above the funding ratio observed in 2012, when the S&P 500 was less than half of its current price. It’s hard to know exactly what has driven the risk aversion of households in the post-crisis era, but in the context of an aging society it’s certainly possible that there is some sort of Ricardian equivalence at work as individuals anticipate lower retirement investment returns and/or higher taxes moving forward.
Of course, this sort of issue is a relatively low priority for the Fed and indeed other central banks, even though the mathematics of asset-liability matching have encouraged pensions to buy copious amounts of duration almost regardless of the anticipated return. Is it any wonder that global central banks cannot escape the hellscape of low rates and inflation? Perhaps a dose of Fed jawboning may be enough to spur equities higher, or maybe Powell will need to plant a few more magic beans by cutting rates again. Unfortunately, in the pension industry, all those beans are likely to grow is tumbleweeds.