Dive in applause? It’s starting to get ugly in the U.S. pension system – global markets

The government bond market boils down to the beginning of the year World bond yields are now declining sharply and are now trading at an all time low. The low yields are gnawing on the business models of financial companies – banks and insurance companies. However, with a broader view of the US – the fall in bond yields creates a big problem in the pension system and it is starting to look particularly ugly.

In order to understand the current problem of the US pension system, two concepts are needed: defined benefit funds (de fi ned bene fi t or DB), and de fi ned contribution plan (or de fi ned contribution) or DC shortened. In DB pension funds, the insured knows from the beginning the rights he is entitled to at his retirement age. In contrast, DC pension funds do not guarantee a predetermined rate or level of periodic payment. Payment is determined by an actuarial calculation based on the life expectancy of the colleague, the fund’s asset inventory and other parameters (such as in Israel).

Until recent decades, most US pension funds have been DB type, but given the deficits accumulated in these funds as a result of demographic changes, since the 1980s the US private sector has gradually shifted to DC type funds, allowing companies to carry out actuarial balances. However, this process did not occur in the government sector in the vast majority of US states.

Another approach argues that this approach is unacceptable because it does not comply with generally accepted accounting standards and is in fact an attempt by the pension funds to create an optimistic picture of future liabilities. According to the latest approach, the discount rate should reflect the risk of the liabilities and not the risk of the assets. Therefore, following the fact that the pension funds are financed and secured by the government, the discount rate should reflect the yield in the bond market on riskless assets such as Government. In such a situation, discount rates should be much lower, especially given the yields on government bond markets are at a historic low.

In 2015, the US Federal Reserve (FED) attempted to address the issue by examining the linguistic causes of discounted interest rate estimates. The Fed’s research did justify setting different capitalization rates among the various U.S. pension funds, but at the same time The consensus among economists around the assessment that public sector pension funds are making their assessments of the value of current liabilities at a discount rate is higher than required.

The Fed’s conclusions were neglected, for the simple reason that, if implemented, would mean a bankruptcy of the U.S. public pension system. For example, using a 3.2% discount rate would raise the current value of liabilities in the California state pension fund, and in fact the fund Bankruptcy had to be announced already.

Effects on stock markets
Another argument by opponents of the current method of calculating pension funds is that the current method actually encourages pension fund decision makers to make investments in risky assets – by investing in risky assets such as stocks today, higher returns can be achieved, and using this return as a discount rate will result in a reduction in value. The current of the liabilities in the next period – which contradicts the financing theories regarding expectancy / risk.

At the same time, the fact that the yields on the bonds have fallen to a historic low in recent years, and the demand to achieve a return of about 7% per year has led to a significant increase in the pension funds’ exposure to the stock market in recent years.

According to recent fund balance sheets, US government pension funds’ exposure to the stock market has risen to 50% -60% over the past year, compared with a historic 35% -30% ratio, with the aim of achieving a higher return, but the risk of portfolio investment The screenings went up significantly.

Simply put: In order to overcome the low interest rates in the market, US pension funds are radically exposed to stock markets. The only way to prevent bankruptcy of the US pension system is a sharply rising stock market. What happens in the event of market declines like last month?

The answer to the question – The California Public Pension Fund (CalPERS) announced last week that following the declines in the last week of February, the value of its managed assets has dropped from $ 400 billion to just $ 385 billion. We note that even before the recent declines, the fund’s ratio (ie the ratio of assets to future liabilities) was 70% -75%. We also note that CalPERS is using a discount rate of 7% in the current year – far from risk-free interest.