Erosion on Earnings: The Current Story of Pensions

Sharp fall in earnings on investment of public pension funds in the US are raising concerns about the security of millions of workers.

At the height of Greece’s debt crisis in 2015, one saw pictures of pensioners queuing up in front of government offices to collect their monthly paychecks amid reports of pension cuts. Protests intensified and even turned violent as these cuts were followed by imposition of higher taxes and pension contributions for current workers.  In the US too, the health of public and private pension funds has become an area of serious concern, raising the prospect of unsustainable futures. Pension funds in recent years have seen erosion in their returns on investment due to recession and low bond yields, while they have piled on higher risk in their balance sheets through diversification. The state of California alone faces funding gap of around $40 billion forcing taxpayers to face the consequences.

In the ongoing discussion on quantitative easing (QE) as a tool for reviving the economy, the effects on saving and investment options has received a rather scant attention. Pension funds could offer rates of around 7.5% to employees by investing in fixed income securities like government bonds that offered high rates of interest over the long term. Today, with interest rates so low in most of the major economies, yields of government securities have fallen forcing pension funds to diversify into riskier assets like private equity to be able to provide the same benefits as before. Data by the Annual Survey of Public Pensions USA shows that government securities make up only 7.6% of public pension fund assets as compared to 22%, two decades ago. Different forecasting exercises by experts have turned up similar result- that a portfolio with both equities and bonds will generate nominal returns of around 4-4.5% in the future, falling far short of the 7.5% promised by pension funds.

Improvement will depend on reducing the funding gap through lower dependence on taxpayer money and a return to normal rates of interest so that fixed income securities can become a higher proportion of the assets. Despite showing optimism with regard to direction of the economy and the country’s unemployment rate, the Federal Open Market Committee (FOMC) has refrained from raising rates in all five of its previous meetings. However, if the country does not wish to drain out pension funds any further, the long-awaited liftoff from sub-zero interest rates must not be delayed.

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