(June 13, 2012) — The yield on long-duration Danish debt is surging after the government allowed the country’s pension funds to alter the discount rate that they apply to calculate their benefit obligations.
Raising that discount rate would slash the liabilities of Danish pension funds and lessen their demand for long-term fixed income. In a similar move on June 7, Sweden’s regulators instituted a temporary floor to the appropriate Swedish discount rate. As a result, liabilities plummeted and the yield on the country’s bonds exploded.
“[Pension funds] won’t be forced to keep buying long bonds,” Michael Grahn, an analyst at Danske Bank A/S in Stockholm, told Bloomberg at the time. “They will get out of this spiral which means that they’re selling off and that probably eases somewhat pressure on the stock market.”
Nordic pension funds have been squeezed on both sides by the Eurozone crisis. While the continent’s poor market performance has sapped their returns, their liabilities have also jumped as capital pours into their countries’ bonds, which depresses the discount rate that determines their funded status. Although a radical step, allowing pension funds to raise the relevant discount rate could be the best way for these plans to avoid being caught in this pincer.
After the difficult month of May many pension plans throughout Europe and the United States have seen their liabilities outstrip their assets. On June 12, the Pension Protection Fund, the United Kingdom’s equivalent of the Pension Benefit Guaranty Corporation, sounded alarms with its statement that in May the combined deficit across the country’s pension funds had reached its highest level since it began collecting data on it seven years ago, aiCIO has reported. Likewise, in May the funded status of the average corporate pension plan in the United States dropped to its lowest level since 2007.
Manipulating discount rates, however, is no silver bullet for eliminating pension deficits. Many pension schemes worldwide face daunting liabilities, and while raising the discount rate would lessen them in the actuarial sense, at some point those benefits will still have to be paid. Indeed, most analysts blame the abject state of public pension funding in the United States in part on the generous discount rate that the Governmental Accounting Standards Board permits them to use.