As private pension funds struggle to meet their obligations in a low-yield environment, companies are making their plight even worse by pushing for unrealistically high discount rates, MFS Investment Management Chairman Emeritus Bob Pozen warns.
In an Aug. 20 opinion for the Brookings Institution co-written with Theresa Hamacher, president of the National Investment Company Service Association, Pozen (left) argues that Congress’ recent decision to use a discount rate based on bond yields averaged over 25 years rather than the previous two years does a major disservice to private pensions.
The authors note that the discount rate, meaning the interest rate on high-quality corporate bonds that is used to determine a pension plan’s expected future return, plays a key role in calculating pension plan obligations. And with the unrealistically higher rate now in place, pension plans will suffer, they warn.
“While an averaging period of five to 10 years might better reflect more ‘normal’ conditions, a 25-year averaging period, as enacted in the U.S., clearly goes too far. Interest rates in 1988 are unlikely to have much predictive value for the next 10 to 20 years,” Pozen and Hamacher write in their opinion piece, “A Realistic Discount Rate for Pensions.”