Public Pensions: Overly Optimistic

 

The BloombergView has an article about some of the little secrets embedded in public pensions.  While the article focuses on the discount rate of future liabilities, the assumed discount rate is tied directly to the assumed future rate of return on investments.

Pension fund management, in conjunction with the fund’s consulting actuaries, establish expected rates of return for different asset classes and then apply the fund’s target asset allocation to come up with an expected rate of return.  These expected rates of return are driven by long-term (50+ years ?) historic returns.  These assumed returns range from 6.5% to 8.5%.

Politicians/elected officials have historically supported using a high assumed rate of return because it reduces the required contributions vs. a lower assumed rate of return.  This reduces budget pressures and the likelihood of reelection.

BloombergView article