US Pensions Are Massively Underfunded, And Have Ridiculously Rosy Assumptions

A piece in the WSJ on the rosy forecasts that US pension funds are making is getting a lot of buzz.

Here's the key stat:

The country's 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.

Given how low rates are, and how dicey the economic outlook is, this seems insane.

But it's all about extending and pretending.

After all, reducing expectations is very costly:

The Colorado Public Employees Retirement Association showed in its 2009 financial report the impact of reducing the rate. Using a 8% expected return rate, the plan faced a $23.4 billion deficit, based on market values, at the end of 2009. If the rate was cut to 6.5%, the shortfall would jump to $34 billion.

Meanwhile, Kid Dynamite makes a great observation:

One thing that still makes no sense to me, and perhaps a reader can help me out with this, is how pension funds can be buying long term corporate bonds (I mean REALLY long term, I'll get to that in a second) with returns below their annualized bogey. Last month Norfolk Southern issued "century bonds," due in 100 years. Their yield was around 6%. Last week, Rabobank did the same thing, issuing 100 year bonds with a yield of around 5.8%. The WSJ says "Life insurers and pension funds tend to be the main buyers for such lengthy bonds because they need to match their long-term liabilities with assets of a similar duration."

Now, correct me if I'm wrong, but if you're making a super long term investment with a 6% return, your long term return assumptions probably shouldn't be in the vicinity of 8%, right? What do you do to recoup the difference - make up for it in volume?