Fitch has adjusted the expected discount rate for public pensions to 6% from the rating agency’s previous 7% expected rate of return. This change is based on what the rating agency views as slowed economic growth that will adversely affect investment returns for public pension funds- a possible repeat last year investment earnings decline seen by public pensions.
According to a source in the agency, the US economy has been exhibited signs of sluggishness. That does not bode well for investment performance. Public pensions are eager to maintain returns in order to lessen their future liabilities. Nevertheless, the current market environment does not appear to lead itself to the capturing of easy returns. For public pensions, this will result in the potential increasing of future liabilities. Estimates place the expected increase of future liability public pensions at upwards of 11%. Public pensions will either have to increase the amount of contributions to the funds or decrease the expected payouts. Both actions would be advisable but will undoubtedly cause consternation among public employees.
Shifts in the aging population could have impacted the current economic picture. As baby boomers continue to retire, work force participation is certain to decrease which will affect the overall market. The elderly are also living longer. Actuarial updates for public pensions will be required to reflect these changes. Currently, the define benefit plans that are offered to public employees do not appear to be sustainable as many struggle with underfunding, violate market environments, and increased number of participants requiring payouts. In order to combat this, the pension system have invested in a more diverse range of equity, fixed-income and alternative assets- a reaction to today’s low interest rate environment. Nevertheless, such investment strategies are bound to increase volatility with the possible result being the unintended consequences of lower investment returns. Thus, this has the potential to further exacerbate the already stressed public pension system.
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No simple solutions are readily available. And one can make an argument that the current discount Rate For Public Pensions should be cut even further.