The Pension Fund Dilemma of Low Interest Rates

Last update on: Feb 12 2020
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While individual investors fret about zero interest rates around the globe, the low rates also are creating substantial problems for pension funds, life insurers, and an array of other entities that depend on investment returns. This article in The Wall Street Journal delves into detail how bad zero interest rates are making pension funding. (Subscription might be required.) The problem is global. When central banks keep interest rates near zero, or even below zero, pension funds find it very difficult to earn the rates of return they need. They could take more risk with their investments, but then they also take the risk of losing money and making the situation worse. Not mentioned in the article is what happens to pension funding when the next bear market hits. Dealing with losses and then trying to recover them when interest rates are near zero will be very difficult.

Pension funds around the world pay benefits through a combination of investment gains and contributions from employers and workers. To ensure enough is saved, plans adopt long-term annual return assumptions to project how much of their costs will be paid from earnings. They range from as low as a government bond yield in much of Europe and Asia to 8% or more in the U.S.

The problem is that investment-grade bonds that once churned out 7.5% a year are now barely yielding anything. Global pensions on average have roughly 30% of their money in bonds.

Low rates helped pull down assets of the world’s 300 largest pension funds by $530 billion in 2015, the first decline since the financial crisis, according to a recent Pensions & Investments and Willis Towers Watson report. Funding gaps for the two biggest funds in Europe and the U.S. have ballooned by $300 billion since 2008, according to a Wall Street Journal analysis.

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