Risky Pension Investment Strategy

Found this on Unbossed and Shirah agreed to let me cross post it!!

Monday, April 28, 2008
The New Risky Pension Investment Strategy
For workers lucky enough to still have defined benefit pensions, PBGC, the Pension Benefit Guaranty Corporation, is their protection from destitution in old age. Take the 1600 former employees of the now bankrupt Austin Co. in Cleveland, Ohio. Because the PBGC stepped in, those employees will get pensions.

But the PBGC can't do this forever, and it is especially challenged in this financial climate. So you can imagine that it might be tempted to make high-return, high-risk investments. And you'd be right.

That is exactly the message in an opinion letter from Peter R. Orszag, Director, Congressional Budget Office to Congressman George Miller, Chairman, Committee on Education and Labor, last Thursday, April 24, 2008. link

According to the CBO, at the end of 2007, PBGC reported that its current liabilities for distressed pensions exceeded the value of its current assets by an estimated $14 billion. The PBGC's solution is to change the mix of its portfolio to include riskier investments.

Prior to February of this year, PBGC’s investment strategy was to hold about 75 percent of its portfolio in bonds, with the duration of those assets matched to the corporation’s obligations. The remainder of the portfolio was invested in equities. PBGC’s new strategy reduces to 45 percent its allocation to fixed-income assets, in order to increase the proportion devoted to equities (45 percent) and to further diversify into alternative asset classes (10 percent).

The change in investment strategy represents an effort on the part of PBGC to increase the expected returns on its assets and to diminish the likelihood that taxpayers will be called on to cover some of its liabilities. The new strategy is likely to produce higher returns, on average, over the long run. But the new strategy also increases the risk that PBGC will not have sufficient assets to cover retirees’ benefit payments when the economy and financial markets are weak. By investing a greater share of its assets in risky securities, PBGC is more likely to experience a decline in the value of its portfolio during an economic downturn—the point at which it is most
likely to have to assume responsibility for a larger number of underfunded pension plans. If interest rates fall at the same time that the overall economy and financial markets decline, the present value of benefit obligations will increase, and the pension plans likely to be assumed by PBGC will be even more underfunded as a result.
. . .
Although increased investment in risky securities will likely raise the expected rate of return, it also entails a greater downside risk. That risk is the probability that the value of PBGC’s assets will be below the amount necessary to meet benefit obligations as they come due, imposing on taxpayers a potential burden that increases as the shortfall grows larger.

Well, as the Ferengi Rules of Acquisition say:

Rule 62 The risker the road, the greater the profit.