Thursday, February 23, 2017

Moody's On Expected Returns: For Pensions, Its As Bad As You Thought It Was

One of the links at today's FT Alphaville Further Reading post (CalPERS’ Private Equity Portfolio Continues to Earn Way Too Little for the Risk) reminded me we had put this together last week.

From Moody's:

“State and Local Government — US: Softening Investment Expectations Signal Accelerating Budget Pressure from Pensions.”
Moody's: Lower investment expectations are accelerating state and local government pension costs
Global Credit Research - 17 Feb 2017

New York, February 17, 2017 -- Budgetary pressure from pension costs is accelerating for US states and local governments as many large public pension systems lower their assumed discount rates to reflect lower investment return expectations, Moody's Investors Service says in a new report. 
Under public pension accounting and funding practices, pension costs have been held down by high assumed discount rates, tied to high investment return targets. The recent trend of lowering discount rate assumptions, as seen with California Public Employees' Retirement System (CalPERS, Aa2 stable) and the California State Teachers' Retirement System (CalSTRS, Aa2 stable), will require most participating municipalities to raise their pension contributions, which can pressure budgets. 
The gap between market interest rates and the discount rates of public pensions has been widening for two decades, and remains substantial even with the lower assumed returns. As interest rates have fallen, public pensions have responded by reaching for yield in order to maintain high assumed rates of return.

"Many large US public pension systems are dropping their return assumptions in response to lower investment outlooks ," Thomas Aaron, a Moody's Vice President -- Senior Analyst says. "In a market context, these discount rate declines by public pension funds are well overdue," says Aaron. 
Numerous market observers have reduced their investment return expectations for the next decade, and multiple large pension systems in states and major cities have dropped their discount rates. Nationally, remaining plans with discount rates above 7.9% are likely candidates for reduction. 
In some cases, falling discount rates are accelerating the pace of rising pension costs by requiring higher contributions from participating municipalities....MORE
If you want to see the difference between market and plan assumptions here's the U.S. Pension Tracker.