Our story explaining how the USPS FERS surplus could drop billions of dollars as a result of a half percent change in interest rates drew a number of comments on Facebook and Disqus, many of them skeptical. This one was typical:
I’m not buying it. I know enough that dropping an interest rate 1/2 of a percent does NOT equal a gigantic loss in ANY investment. If that were the case, as my postmaster said earlier in the day, “If there was such a big drop, regular companies would lose trillions of dollars.”
Oh really? Lets do the math!
In yesterday’s story I used the example of what happens to a thousand dollars over 25 years. The FERS fund has billions of dollars in it, so let’s talk billions! (And see the spreadsheet at the bottom of the page if you want to check my math…)
Start with, say, $60 billion. Use the OPM’s original interest rate of 5.75%. As the first column in the spreadsheet shows, after 25 years, your $60 billion has grown to $242.8 billion. Let’s assume that that’s exactly what we need in order to meet our pension obligations 25 years from now.
Now let’s change the interest rate assumption just as OPM has done, to 5.25%. The second column shows that after 25 years at 5.25% our fund has grown to just $215.6 billion, $27 billion short of what we need.
The third column shows how much money you’d need to start with in order to get to your target $242.8 billion at the lower interest rate- it turns out to be a difference of $7.5 billion.
In other words, an interest rate change of one half of a percent results in a $7.5 billion deficit.
The individual who made the “not buying it” comment is forgetting that we’re talking about huge sums of money, and long time periods. The actual balance in the USPS FERS fund at the end of 2011 was $87.3 billion, and OPM needs to calculate returns decades in advance. On that kind of scale, as the spreadsheet shows, a half a percent difference in interest rates can indeed result is a swing of billions in the future value of a fund.
There is, however a kernel of truth in that postmaster’s comment “If there was such a big drop, regular companies would lose trillions of dollars.” As a matter of fact, they probably would. And that’s why very few private companies offer defined benefit pension plans. As the NASRA report I mentioned yesterday explains:
Unlike public pension plans, corporate plans are required by federal regulations to make contributions on the basis of current interest rates… this method results in plan costs that are volatile and uncertain, often changing dramatically from one year to the next. This volatility is due in part to fluctuations in interest rates. This volatility has been identified as a leading factor in the decision among corporations to abandon their pension plans.
You can imagine what the USPS FERS deficit would be if OPM used current interest rates of around one percent to calculate future returns!
As I mentioned yesterday, there are many other factors involved in determining how much money OPM should have on hand now in order to meet future pension requirements. The USPS Inspector General makes a good case for the argument that OPM uses faulty assumptions about postal workers’ pay and longevity, thereby overstating the amount USPS needs to pay into the system. As a result, the OIG says the current FERS surplus is actually $24 billion. Keep in mind though, that the OIG’s estimate is still based on OPM’s earlier interest rate estimate of 5.75%. Lowering the rate assumption would also lower the OIG’s estimated surplus by billions of dollars.
Note- figures in the table are in millions.