Interest Rates: Setting the Record Straight

As policymakers consider reforms to the rules governing multiemployer pension plans, one of the issues they will evaluate is the appropriate interest rate for funding these plans. Pension funding is fundamentally a long-term process, and while financial markets produce both exceptionally large gains and losses over short time periods, the long-term experience of the markets has been remarkably stable.

Many plans saw their funding levels fall dramatically in 2008 when the S&P 500 lost 37% of its value in a single year. Yet even in the wake of such catastrophic – and recent – losses, assuming an annual return of 7.0% or 7.5% remains appropriate given historical performance. Let’s look at the facts:

  • At the end of 2008, the absolute lowest point in the recent financial crisis, the 30-year average of the S&P 500 returns was 10.99% – including that year’s 37% loss.
  • Since the inception of the S&P 500 average in 1926, the 30-year average – for any 30 year period – has never fallen below 8.47%.
  • While it is true that our economy faces serious challenges today, we also need to remember that past generations have faced equally daunting challenges, but through it all the long-term financial market performance has remained strong.

Over the longer time periods that are relevant to pension funding, financial market returns have been reliably stable and strong. Let’s look at how this impacts multiemployer pensions:

  • A typical multiemployer pension plan might hold roughly 50% of its assets in equity securities, and 50% in fixed-income securities. In our “Solutions Not Bailouts” recommendations, we do not propose any changes to the anticipated rates of return between 7.0% and 7.5% that most plans currently use. Some critics call for an anticipated rate of return as low as 5.0% or less. This would be a mistake.
  • Just as it would have been unwise to raise long-term expectations following the boom markets of the late 1990’s where the S&P index exceeded 20% for five consecutive years, it is also unwise to lower long-term expectations today.
  • Since the 1926 inception of the S&P 500 average, the historical returns of the financial markets have never produced a 30-year return of 5.0% or less for a balanced investment portfolio of 50% equities and 50% fixed-income securities. In fact, it’s not even close.
  • Even druing the single worst period on record, from 1929 to 1958 – following the Great Depression, World War II and the Korean War – a balanced portfolio produced an average return of approximately 6.7%.
  • In more than 90% of the 30-year periods that the market has experienced, the return, for a balanced portfolio, has exceeded 7.0%, and the median return for these periods is 8.5%.

The “Solutions Not Bailouts” approach to interest rates resists the temptation to overreact to short-term trends, whether positive or negative. Instead, we looked at nearly a century of historical financial data when making our recommendations for how to safeguard retirement security for multiemployer plan participants, protect taxpayers and spur economic growth.