Young Versus Old Will Define Fight Over Public Pensions

The firestorm among UK pension funds is a wake-up call for their peers across the Atlantic. The end of an era of cheap money is exposing an industry that’s chronically underfunded and overexposed to market turbulence.

Imagine a meeting of executives of a typical public pension fund following last quarter’s rout.

Chief investment officer: 2022 has been brutal. 60% of our fund is invested in equities, they’re down 25%. Another 20% is in bonds, which are down 15%. 20% is in alternatives. Commodities and hedge fund strategies have done well overall, but real estate and private equity are down. Overall, we’ve lost 15% of our asset value.

Chief accountant: Not to worry. 30-year interest rates have almost doubled from 1.90% to 3.71%. Since we have long-duration liabilities, the present value of our pension obligations has declined 20%.

Head actuary: Not so fast. With inflation running at 8.3%, we’re going to see large cost-of-living adjustments in liabilities. Plus, inflation and a tight labor market mean wages will increase. Higher wages mean higher future pension benefits.

I will leave these professionals to thrash out the net effect on their pension fund though clearly, they face numerous crosscurrents. Investment returns, discount rates and inflation all affect the reported funded status of a pension plan — or the assets currently held relative to long-term obligations — an abstraction based on unknowable assumptions. Whether the average fund will pay out its promised liabilities or not is something we won’t know for decades.

What matters in the knowable here and now is whether some of the worst-funded large plans will collapse in the next year or two. If yes, we’ll have to deal with a major financial crisis soon. If no, pension funds can continue to muddle along — whether the officially reported statistics around their funded status look good or bad — until the next crisis.