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Originally Posted by Slava
Well this is about more than the teachers pension though. The problem for administration of these pensions is that you have to accurately predict the future benefits required, and have the returns and discount rate (which also has to be accurate), at least match up. Getting the benefit required is crucial, and not simple. As people live longer, it adds to that obligation which is entirely on the sponsoring entity. This is a chunk of the issue when it comes to the funded status of a pension fund.
Pension fund management faces a few specific issues as well. Today, after basically twenty years of declining interest rates, bonds gave a good boost to these portfolios, and that meant things like pensions could get decent returns while sticking to a balanced mandate. How does that look going forward with rising interest rates? Those balanced mandates with 35-40% in fixed income probably return closer to 5% than they would’ve say a decade ago where they could get 8-9%. That’s a problem, and again that risk is entirely with the sponsor.
Longevity risk is the main factor though, and there are only a few things a pension can do to deal with this. They can use a couple options to transfer that risk to insurers (some of these depend on whether the pension is closing or remaining open). Or they can increase the risk of their assets and hope their asset allocation will help bridge the gap. None of those “solutions” are free though. You either straight up add risk, or literally pay someone else to take the risk off your plate.
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I think you mistate how the longevity risk manifests itself. The longevity risk isn’t people living longer, that is already priced into the plan. It’s the rate of increase in average life increasing faster than predicted by the plan.
People don’t just all of a sudden live longer. It’s a slow and gradual trend. It’s also not the reason why the current plan or any private plan had issues. The problem in all of the old pension plans was relying on future workers to pay for existing retirees rather than having current employees paying for their own futures. These situation aren’t lack of returns or longevity risks. They were fundamental underfunding that was intentional and clear when these plans were funded.
Are there good examples of funds that were not relying on future worker contributions to fund existing retirees that have gone bankrupt?
I would argue the risks you state get priced in as pension contributions are adjusted.