Way off base
If you assume a high return on your assets, it is easy to imagine that the pension problem will go away. There is a neat illustration in the latest report from the Center for Retirement Research at Boston College. By and large, it is a fairly sensible report; the team there has a deserved reputation for careful research. They use the official pension numbers (the ones that allow states to discount liabilities by the assumed level of investment return) to reckon that the funding level of state pension plans fell from 75% to 73% in 2012. They also use a more realistic discount rate of 5% to come up with a funding ratio of 50%, akin to the one calculated by Moody’s last week. They calculate that liability growth has slowed because states have been able to reduce cost growth, largely by reducing staff, freezing salaries or, in some cases, reducing the cost-of-living adjustment for pensions in payment. Nevertheless, the annual retired contribution for states has risen from 6.4% of payroll in 2001 to 15.3% last year.
GASB is introducing new rules which go some way to meeting the view of economists that pensions are a debt-like liability and should be accounted for accordingly. The CRR also calculates the funding ratios under those rules and finds that it is around 60% (an alarming figure on its own).
But what made your blogger spill his coffee was the section of the report that dealt with the outlook for equity returns; the CRR has three scenarios, a baseline of 7.75%, an optimistic return of 11% and a pessimistic return of zero. How is that baseline figure calculated? Turn to the footnotes. The assumptions are that output grows 5.75% a year (3.5% real, 2.25% inflation), profits rise in line with GDP, and the p/e is 17 at the end of 2016. In essence, you get profits growth of 5.75% a year plus your dividend yield of 2% to get to 7.75%.
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