Discount Rate Conspiracy Theories

The theme of 2014, so far, appears to be one of denial, specifically data denial — at least within the pro-big-government alliance.  Ignore the unemployment rate.  Ignore the hundreds of wealthy Rhode Islanders leaving (on net).  It’s a good thing that ObamaCare is slated to cause millions of jobs to evaporate.

Now the meme has progressed to pensions.  Responding to the revelation that Providence’s pension system is less than 40% funded, even after “reform,” firefighter union president Paul Doughty doesn’t express outrage, or even concern, over the threat to his members’ retirements, but rather alleges an investment-advice conspiracy:

Some investment experts recommend an even lower rate [when calculating predicted investment returns]. Moody’s Investors Service recommends 5.5 percent. Investor Warren Buffet has suggested 6 percent. …

A lower rate would dramatically increase estimates of the unfunded liability, Doughty said: “The calculation at that point is the fund is much more—much more—unfunded.”

Higher estimates for an unfunded pension liability becomes an impetus for further pension reform, potentially including the creation of individual retirement accounts, instead of (or addition to) one pension fund with contributions from all workers pooled together, Doughty suggested. When financial institutions are processing transactions for thousands of workers, rather than just city, they stand to make more money, he concluded.

Never mind that the bread and butter of investment advisors is proof that they can be accurate.  It’s also a bit odd to think that a company would rather have to compete for thousands of small accounts than have ownership of a handful of very large accounts.

The biggest problem with Doughty’s conclusion, though, is that a higher discount rate requires the pension fund to gamble on higher-risk investment products, which require more supervision and advice.  (Hence the argument over fees for hedge funds.)

If the discount rate (i.e., predicted investment return) is a few percent, the advice would be to buy a bunch of long-term bonds.  If the discount rate nears 10%, the advice is: “Give me a bunch of money to analyze the market and find the most profitable investments on an ongoing basis.”

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