Saturday, March 12, 2016

Low rates clobber pensions

Pension Pulse: When it comes to pension deficits, keep your eyes peeled on bond yields because the lower they go, the more future liabilities and pension deficits rise. And when asset values drop, it adds more pressure on pensions, especially if they're chronically underfunded like many U.S. state, city, municipal and local pensions are.

Right now, stocks have erased almost all of the 2016 losses but U.S. bond yields remain at historic lows despite bonds posting the biggest weekly selloff since November after Friday's better-than-expected jobs report. And when it comes to pensions, ultra low rates for years and the new negative normal spell big trouble ahead, especially if deflation sets in.

The critical point to remember is that when rates are at historic lows, every drop in global long bond yields represents a huge increase in future liabilities for pensions. Why? Because the duration of liabilities is a lot bigger than the duration of assets which means that every drop in bond yields disproportionately impacts pension deficits

This is why you see Canada's large public pensions scrambling to buy infrastructure assets like London City Airport at a hefty premium. They need to find assets that are a better match to their long dated liabilities. We can argue whether Canada's mighty pensions are paying too much for these "premium infrastructure assets" (I think so) but this is the approach they're taking to defy volatile public markets and find a better suitable match for their long dated liabilities.
We have low rates because we have low growth. We have low growth because pension and entitlement taxes have squeezed the economy.  This is strictly a baby  boomer issue, one generation imposing its time constraints on the younger generation.  

The millennials are not paying for all these obligations. As Roger Farmer says, they were  not born when the boomers stole the cookies. Millennials have no obligation to pay.  Kanosians should think more clearly about their bogus overlapping generations model, we do not update entitlements often enough to support inter-generational shifts.

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