Low interest rate impact on pensions is two fold. While low interest rates help states borrow money to improve infrastructure, they severely lower returns on public pension plans, which can lead to funding shortfalls. U.S. infrastructure is in dire need of an overhaul; the American Society of Civil Engineers estimates a lack of investment will cost almost $4 trillion in gross domestic product by 2025.
With that in mind, the global trend of debt yields falling below zero seems like a massive windfall for U.S. states and cities. After all, they borrow for public works projects in the $3.8 trillion municipal bond market, where rates are within spitting distance of all-time lows. Just about every state can borrow at less than 2% for 10 years—a better rate than the federal government can get.
But this is hardly a free lunch and the low interest rate impact on public pensions is not all good. With $3 trillion in pension assets, states also face a cumulative unfunded liability of more than $1 trillion, even after the longest economic expansion in U.S. history. What’s worse, that shortfall likely underestimates the problem, as most plans assume annual returns of 7% to 8%. Were the U.S. to enter a recession, with bonds already yielding next to nothing, it would become virtually impossible to meet that target. Indeed, the two largest U.S. pension funds, representing California’s public employees and teachers, respectively, each reported in July that they came up short in 2018, when the S&P 500 was down for the year.
Read the whole article at Bloomberg Businessweek.
This article quotes selections from “Ultralow Interest Rates Bring Opportunity and Danger to States” by Brian Chappatta, in Bloomberg Businessweek, July 29, 2019.