Pension plan forecasted returns - calling WBern

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Lbill
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Pension plan forecasted returns - calling WBern

Post by Lbill » Mon Apr 04, 2011 8:29 pm

I'm wondering how public and corporate pension plans are planning on earning these forecasted rates of return. Wonder what our friend Bill Bernstein would have to say. I don't think he's estimating anything close to these numbers. How does this make any sense?
According to survey data compiled by the National Association of State Retirement Administrators (NASRA), the median assumed rate of return among the largest public funds is 8%, though some funds use estimates as high as 8.5%, and others as low as 7%.

According to Wilshire Associates, the range among the largest corporate pension plans is 6.5% to 8.75%, with an average of 8% as well.
http://portfolioist.com/2011/04/04/esti ... #more-5244
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Nanette Byrnes
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Post by Nanette Byrnes » Tue Apr 05, 2011 7:58 am

I'd be interested to hear Dr. Bernstein's thoughts too.

Based on asset allocation alone, Wilshire estimates that public and private funds would earn far less than the figures the funds themselves predict (in the range of 6.5% versus 8%). The difference appears to be outperformance they expect from their managers.

Another thing that surprised me is how close the expectations for public and corporate pension plans are -- both 8%-- while their typical asset allocation has some big differences. (Corporate plans are now pretty heavily in cash, while public funds have a great allocation to "alternative" investments.

Curious what people think of that.

(I wrote the post at Portfolioist.)

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Cosmo
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Post by Cosmo » Tue Apr 05, 2011 8:11 am

Nanette Byrnes wrote:I'd be interested to hear Dr. Bernstein's thoughts too.

Based on asset allocation alone, Wilshire estimates that public and private funds would earn far less than the figures the funds themselves predict (in the range of 6.5% versus 8%). The difference appears to be outperformance they expect from their managers.

Another thing that surprised me is how close the expectations for public and corporate pension plans are -- both 8%-- while their typical asset allocation has some big differences. (Corporate plans are now pretty heavily in cash, while public funds have a great allocation to "alternative" investments.

Curious what people think of that.

(I wrote the post at Portfolioist.)
After reading the article, I do not see one mention of this being a real rate of return. If not, then these returns are not unrealistic at all, taking inflation into account.

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Post by fishndoc » Tue Apr 05, 2011 8:24 am

Cosmo wrote: After reading the article, I do not see one mention of this being a real rate of return. If not, then these returns are not unrealistic at all, taking inflation into account.
Inflation may end up being more important than AA in determining the nominal return for the defined benefit pension managers.
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Post by Wagnerjb » Tue Apr 05, 2011 8:24 am

The oldest 10-K I can find online for Exxon shows they assumed a 10% rate of return in their 1993 plan assumptions. In 1999 they reported their actual rate of return for the prior decade was 13%. Nobody seemed to be concerned that they underestimated so badly. I don't know why today should be any different.

Remember, these are long-term assumptions, not just what you think the markets will return over the next decade. Long-term returns have been safely within the 8% range, so I don't see the issue here.

Does the CFO have an incentive to push this assumption as high as possible? Maybe. Do the auditors have to sign that they are comfortable with this assumption? Yes. Do investors get to make their own judgments on this data since it is published in the 10-k? Yes.

Best wishes.
Andy

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Post by staythecourse » Tue Apr 05, 2011 8:42 am

I'm not Mr. Bernstein, but don't think those are unrealistic expectations based on long term returns from stocks and bonds if described in nominal terms.

What I do think is a lot less likely is achieving those results with professional money manager and active trading. Usual Bogleheads stuff.

Good luck.
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Post by DblDoc » Tue Apr 05, 2011 9:29 am

staythecourse wrote:I'm not Dr. Bernstein, but don't think those are unrealistic expectations based on long term returns from stocks and bonds if described in nominal terms.

What I do think is a lot less likely is achieving those results with professional money manager and active trading. Usual Bogleheads stuff.

Good luck.
Fixed it for you.

DD

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Post by staythecourse » Tue Apr 05, 2011 10:11 am

DblDoc wrote:
staythecourse wrote:I'm not Dr. Bernstein, but don't think those are unrealistic expectations based on long term returns from stocks and bonds if described in nominal terms.

What I do think is a lot less likely is achieving those results with professional money manager and active trading. Usual Bogleheads stuff.

Good luck.
Fixed it for you.

DD
Thanks.
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Post by ScottW » Tue Apr 05, 2011 10:52 am

Wagnerjb wrote:Does the CFO have an incentive to push this assumption as high as possible?
The higher the expected rate of return, the less money the company has to contribute to meet its future obligations. If the actual return is lower and they find themselves short, well, upper management will have probably moved on to another company by then, so it's no longer their problem.

The following WSJ article discusses the friction between local governments and actuaries forecasting returns. The actuaries want the pension plans to adopt more conservative targets, while governments are fighting back because they fear that doing so will strain their current budgets.

http://online.wsj.com/article/SB1000142 ... DS=pension

It's the same reason so many people continue to smoke and retain other bad habits--any drawbacks are seen as being too far in the future to worry about for now.

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Post by ofcmetz » Tue Apr 05, 2011 11:39 am

In the state pension that I participate in the rate of return is assumed at 8.25% APR. While employee contributions are fixed at 9.5% of our pay, the employer contribution adjust year to year based on the unfunded liability of the plan.

Prior to the 08 09 market crash, employer rates were around 12% of salaries. Now they are set at 25% of salaries. I think it is a case of the governments being strapped financially at this point and not wanting the rates to up anymore in the short term. There is a lot of hope in these forecasts that will cost us a ton in the future if these results dont pan out.
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Post by Wagnerjb » Tue Apr 05, 2011 12:41 pm

ScottW wrote:
Wagnerjb wrote:Does the CFO have an incentive to push this assumption as high as possible?
The higher the expected rate of return, the less money the company has to contribute to meet its future obligations. If the actual return is lower and they find themselves short, well, upper management will have probably moved on to another company by then, so it's no longer their problem.
Exactly. But that is the identical challenge for politicians too. Just like the "upper management" that gets their bonus and moves on before the problem gets bad, the politicians enjoy their power and money and move on to another position, then its no longer their problem.

Luckily, we have auditors that need to attest to the reasonableness of a company's assumptions. And we have transparency since the assumption is clearly published in the Annual Report and 10-K. I am not as well versed on public entities, but I would think the same audit and transparency rules apply in some similar form.

If we don't like the assumptions, we shouldn't vote for the Board or vote to re-elect the Politician either.

Best wishes.
Andy

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Post by alec » Tue Apr 05, 2011 3:17 pm

ofcmetz wrote:In the state pension that I participate in the rate of return is assumed at 8.25% APR. While employee contributions are fixed at 9.5% of our pay, the employer contribution adjust year to year based on the unfunded liability of the plan.

Prior to the 08 09 market crash, employer rates were around 12% of salaries. Now they are set at 25% of salaries. I think it is a case of the governments being strapped financially at this point and not wanting the rates to up anymore in the short term. There is a lot of hope in these forecasts that will cost us a ton in the future if these results dont pan out.
I think this is the crux of the issue. If the revenue streams like taxes of the municipalities/states [and even corporations] are correlated with the investments of the pension fund, then the required contributions will go up a lot at the same time when tax revenues are falling quickly and the municipalities/states cannot make the contribution.

It's kind of the same reason why individual's whose earnings are correlated with the stock markets should probably not invest a lot in equities.
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Post by Noobvestor » Tue Apr 05, 2011 8:19 pm

DblDoc wrote:
staythecourse wrote:I'm not Dr. Bernstein, but don't think those are unrealistic expectations based on long term returns from stocks and bonds if described in nominal terms.

What I do think is a lot less likely is achieving those results with professional money manager and active trading. Usual Bogleheads stuff.

Good luck.
FTFY

DD
FTFY
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Post by Valuethinker » Thu Apr 07, 2011 6:44 am

Wagnerjb wrote:The oldest 10-K I can find online for Exxon shows they assumed a 10% rate of return in their 1993 plan assumptions. In 1999 they reported their actual rate of return for the prior decade was 13%. Nobody seemed to be concerned that they underestimated so badly. I don't know why today should be any different.

Remember, these are long-term assumptions, not just what you think the markets will return over the next decade. Long-term returns have been safely within the 8% range, so I don't see the issue here.

Does the CFO have an incentive to push this assumption as high as possible? Maybe. Do the auditors have to sign that they are comfortable with this assumption? Yes. Do investors get to make their own judgments on this data since it is published in the 10-k? Yes.

Best wishes.
Warren Buffett had a good piece in about 2000, pointing out how many companies were using 8.5%

His companies were using 6.5%

I think history has shown he was right, and the general consensus wrong.

If you think stocks will do 8% (not unreasonable) and bonds will do 4% or so (again, reflective of current interest rates) then 6-6.5% average is probably not a bad long term shout.

All those numbers are nominal by the way.

If we do it in real terms, then US TIPS are say 1-1.5%, and equities probably around 5-5.5% real. That, again, gets you to a similar level.

In the weird way of actuarial science, the fall in corporate bond rates (used to discount future liabilities, as the key driver of annuity rates) is actually a bigger problem for DB pension schemes than the recent issues with asset market returns (which can be expected to normalize, eventually).

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Post by speedbump101 » Thu Apr 07, 2011 10:40 am

Valuethinker wrote:In the weird way of actuarial science, the fall in corporate bond rates (used to discount future liabilities, as the key driver of annuity rates) is actually a bigger problem for DB pension schemes than the recent issues with asset market returns (which can be expected to normalize, eventually).
Absolutely spot on... The scheme I'm a member of is stress tested on two fronts... The ongoing ability to pay agreed to pension amounts, and also (the biggy) the ability to meet the ongoing (earned as of today) requirements in the event of a wind up.

The first test isn't typically a problem, however the wind up is... I'm told that a couple of percent change in the discount rate would pretty much eliminate the under funding (wind up) flag.

SB...
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Post by Valuethinker » Thu Apr 07, 2011 12:20 pm

speedbump101 wrote:
Valuethinker wrote:In the weird way of actuarial science, the fall in corporate bond rates (used to discount future liabilities, as the key driver of annuity rates) is actually a bigger problem for DB pension schemes than the recent issues with asset market returns (which can be expected to normalize, eventually).
Absolutely spot on... The scheme I'm a member of is stress tested on two fronts... The ongoing ability to pay agreed to pension amounts, and also (the biggy) the ability to meet the ongoing (earned as of today) requirements in the event of a wind up.

The first test isn't typically a problem, however the wind up is... I'm told that a couple of percent change in the discount rate would pretty much eliminate the under funding (wind up) flag.

SB...
I might say 'headed for a crash' but that would be pushing the flight envelope ;-).

UK funds use the A Corporate Bond rate as a discount, and the low interest rates are killing them. You just need so much more assets to annuitize each retiree.

The wind up liability of most DB schemes is truly frightening at these interest rates. A difficult mountain to climb.

that is the problem for STC, which was owned by Nortel, which is now of course insolvent. I don't know quite where it got to, but STC (the old submarine cable laying business) is the UK Pension Regulator's biggest problem.

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Post by Valuethinker » Thu Apr 07, 2011 12:25 pm

ofcmetz wrote:In the state pension that I participate in the rate of return is assumed at 8.25% APR. While employee contributions are fixed at 9.5% of our pay, the employer contribution adjust year to year based on the unfunded liability of the plan.

Prior to the 08 09 market crash, employer rates were around 12% of salaries. Now they are set at 25% of salaries. I think it is a case of the governments being strapped financially at this point and not wanting the rates to up anymore in the short term. There is a lot of hope in these forecasts that will cost us a ton in the future if these results dont pan out.
It is almost certain that employer aka taxpayer and employee will have to share the pain.

These promises were made without reference to their likely costs. We are highly unlikely to have a repeat of the Dow 1,000 to Dow 10,000 and Long bond yield 13% to long bond yield 4%, to bail out the pension funds this time.

I would imagine:

- closure to new accruals and replacement with DC or Career Average Salary schemes
- resolution of issues open to abuse re eg banked holiday and sick pay being used in the pension basis
- some alterations of inflation indexation

In the UK Career Average Salary schemes have now been proposed by a government appointed inquiry, and inflation indexation has been significantly reduced (by switching from RPI to CPI ie about 0.5 to 1.0% less pa).

To my mind, Career Average Salary seems the fairest to public servants. Long term public servants on low or capped compensation will get the same (or sometimes higher) pensions. That might be combined with some form of DC scheme.

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Post by Nanette Byrnes » Thu Apr 07, 2011 3:20 pm

Cosmo wrote:
Nanette Byrnes wrote:I'd be interested to hear Dr. Bernstein's thoughts too.

After reading the article, I do not see one mention of this being a real rate of return. If not, then these returns are not unrealistic at all, taking inflation into account.
I had trouble determining whether they were using real rates of return when I reviewed Calpers documents, so I reached out to Keith Brainard, research director of the National Association of State Retirement Administrators, who tracks this closely. He said that the investment return figures used by Calpers (and others) are made up of two elements: an inflation component and a real rate of return.

He sent along a research paper on this topic which is unfortunately not online (though I'm happy to forward to anyone who might be interested). In it he concludes that given their very long time horizons, public pension plans investment assumptions look conservative.

He also acknowledges the fact that an unrealistically high investment assumption:

"could encourage these funds to take too much risk in investing pension fund assets, or it could understate the cost of pension liabilities, reducing their current cost at the expense of future taxpayers. Alternatively, an investment return assumption that is set too low would result in overstating liabilities, which would overcharge current taxpayers."

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Re: Pension plan forecasted returns - calling WBern

Post by baw703916 » Thu Apr 07, 2011 4:40 pm

Lbill wrote:I'm wondering how public and corporate pension plans are planning on earning these forecasted rates of return.
If I were to impersonate Dr. Bernstein and tell you that there's no way they can achieve those rates of return, I'm curious as to how you plan to act on this information.

Brad
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Post by bowest » Thu Apr 07, 2011 5:01 pm

Wagnerjb wrote: Warren Buffett had a good piece in about 2000, pointing out how many companies were using 8.5%

His companies were using 6.5%
Buffett's current 2010 10-K (issued in late February) assumes a 7.1% return on pension assets, up from 6.9% in 2009. So he's become slightly more bullish despite a 13% S&P500 gain in 2010.

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Post by Valuethinker » Fri Apr 08, 2011 2:49 am

bowest wrote:
Wagnerjb wrote: Warren Buffett had a good piece in about 2000, pointing out how many companies were using 8.5%

His companies were using 6.5%
Buffett's current 2010 10-K (issued in late February) assumes a 7.1% return on pension assets, up from 6.9% in 2009. So he's become slightly more bullish despite a 13% S&P500 gain in 2010.
Thank you. The S&P has not moved since 2000 so his hindsight judgement was proved correct.

6.9% strikes me as slightly on the high side but who am I to argue with Warren Buffett? ;-). ;-). (asset mix of course impacts).

4% bonds. 8% equities. It seems to me not a bad estimate (UK equity returns historically have been lower than US, which may account for part of the difference).

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Post by richard » Fri Apr 08, 2011 10:28 am

Nanette Byrnes wrote:I had trouble determining whether they were using real rates of return when I reviewed Calpers documents, so I reached out to Keith Brainard, research director of the National Association of State Retirement Administrators, who tracks this closely. He said that the investment return figures used by Calpers (and others) are made up of two elements: an inflation component and a real rate of return.
Thanks to Nanette, I was able to track down an online copy of the paper.

It concludes
Empirical results show that since 1985, a period that has included three economic recessions and four years when median public pension fund investment returns were negative (including the 2008 decline), public pension funds have exceeded their assumed rates of investment return. As the standard disclaimer says, past performance is not an indicator of future results. However, considering that public funds operate over very long timeframes, actuarial assumptions with a long‐term focus should also be established and evaluated on similar timeframes. Viewed in this context, compared to actual results, public pension plan investment return assumptions have proven to be conservative
http://www.nasra.org/resources/InvRetur ... _Final.pdf

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