Date posted: June 6, 2013
Most states have large public pension funds for employees. Some of these funds are facing immediate financial problems. North Carolina’s fund is not one of them. But some economists say all funds face longer-term issues related to something called the discount rate. What is this possible problem? N.C. State University economist Mike Walden responds.
“Well, this sounds like we’re getting in the weeds of economics and investing, but really, we’re not. If you have a certain amount of money — let’s say a pension fund in North Carolina’s case, about $80 billion worth of a pension fund — and you’re trying to calculate whether you are going to have enough in that fund to pay off future retirees, pay what you promised.
Obviously, when you’re looking ahead, that pension fund is going to get additional funds from working state workers as they contribute. It’s going to get, possibly, funds — as in North Carolina’s case — from the state, and it’s also going to get funds from its investment earnings.
Now, a standard technique that pension funds and other investment funds use in order to calculate whether they are going to have enough money to pay out retirees down the road is to do what’s called discounting those future payments to see if that discounted amount equals what they have right now, sort of in the bank.
And the problem or issue that many investment analysts say is occurring with many investment funds is that the discount rate they’re using is very high, around 7 percent. And the way to look at this is that it effectively is saying that when you account for all of the sources of income in the future for the pension fund, the pension fund is going to be growing by about 7 percent a year per person, per retiree.
And many investment analysts say, ‘hey, that’s way too high when you look, for example, at the return on safe bonds.’ So, this is a question, it’s not just a question for North Carolina, it’s really a question for all pension funds whether we’re perhaps shielding or masking some of the looming problems down the road by assuming those funds are going to earn a very high of return.”
Category: Economic Perspective