Pensions: Even worse than they seem

by John Rubino
Posted originally September 18, 2010

AN ARTICLE IN TODAY’S WALL STREET JOURNAL ILLUSTRATES YET ANOTHER LIE we’re being told. It seems that pension funds, despite plunging interest rates and negative returns in the stock market over the past decade, are still assuming an 8% annual return on their assets. This allows them to pretend to be more fully funded than they are. Here’s an excerpt:

Pension Gaps Loom Larger
Funds Stick to ‘Unrealistic’ Return Assumptions, Threatening Bigger Shortfalls

Many of America’s largest pension funds are sticking to expectations of fat returns on their investments even after a decade of paltry gains, which could leave U.S. retirement plans facing an even deeper funding hole and taxpayers on the hook for huge additional contributions. The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.

The country’s 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.

Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor’s 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst’s Accounting Observer, a research firm.

The rosy expectations persist despite the fact that the Dow Jones Industrial Average is back near the 10000 level it first breached in 1999. The 10-year Treasury note is yielding less than 3%, and inflation is running at only about 1%, making it tougher for plans to hit their return targets.

Return assumptions can affect the size of so-called funding gaps—the amounts by which future liabilities to retirees exceed current pension assets. That’s because government plans use the return rates to calculate how much money they need to meet their future obligations to retirees. When there are funding gaps, plans have to get more contributions from either employers or employees. The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America’s government and corporate pension plans.

Pension funds at companies in the S&P 500 faced a $260 billion shortfall at the end of 2009, according to Standard & Poor’s. Estimates of the fund deficits faced by state and local governments range from $500 billion to $1 trillion. Another article in today’s WSJ illustrates one possible future for underfunded pensions: