Yale has begun to take steps to address the adverse impact a low interest rate environment will have on retirement benefits for its employees.
In a year of strong financial performance — the University reported an $86 million budget surplus in fiscal 2016 — funding retirement benefits constituted the largest addition in liabilities for the University. Yale’s financial report indicated that these additional contributions were one of the primary factors that led to a 3 percent decline in net assets for the University from the prior year. According to the report, the cost of providing employee benefits increased approximately 7 percent, or $545 million, from fiscal 2015, representing the largest year-on-year percentage-point increase since the 2008–09 financial crisis.
“The low interest rate environment means that we have considerably increased our contributions to the University’s pension plan,” said University Chief Financial Officer Stephen Murphy. ”We are likely to have to continue to increase contributions, and that is going to add pressure to the budget for some time to come.”
Yale offers what is known as a defined benefit pension plan to staff employees in service, maintenance, clerical and technical roles. Unlike the defined contribution plans offered to managerial staff and members of the faculty, the plan does not require participants to contribute any funds toward their pensions.
Amid what financial markets expert William Jarvis ’77 called a “historically low interest rate environment worldwide,” a relatively greater expenditure in current dollars becomes necessary to guarantee that any employer will be able to pay out the pensions promised to employees decades from today.
“We’re at the worst interest rates in our history,” said Yale economics professor and Nobel laureate Robert Shiller, noting that long-term rates and short-term rates were not this low even during the Great Depression. “A lot of assumptions about pensions made under the former higher interest rate regimes are going to need serious revision.”
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Shiller added that Yale is far from the only provider of a defined benefit plan to be impacted by the low interest rates. Before the United States Federal Reserve increased interest rates by a quarter of a percentage point last December, there had been no change in interest rates since the nadir of the financial crisis in December 2008. In the intervening period, The Wall Street Journal reported that major American companies such as Ford and Verizon had joined a long list of companies that were spending billions of dollars to address pension liabilities, and were therefore being “battered by record low interest rates.”
Yale’s retirement plans are also under scrutiny in the legal arena. A group of six plaintiffs including facilities and maintenance workers filed a class-action suit against the University in August, contending that the University’s retirement plans were less cost-effective than alternatives on the market, and entailed the payment of “unreasonable and excessive fees for record keeping, administrative and investment services.”
The suit is currently under review in the U.S. District Court in Connecticut.
Low interest rates not only result in additional pension liabilities, but also impact the returns provided by the University’s endowment, according to Roger Ibbotson, a hedge fund manager and finance professor at the School of Management.
Endowment managers at many institutions including Harvard University and Dartmouth College suggested that low interest rates and its damaging impact on economic growth were partially responsible for their losses this fiscal year. Yale’s 3.4 percent return on the endowment for fiscal 2016 was the best among its peers and one of only five positive returns among universities with more than $500 million in endowment funds.
But because of the distribution of $1.15 billion of endowment funds — more than the endowment’s returns for the year — to the University’s operating budget, the endowment declined in market value.
“This situation is a reminder that Yale will need to continue to manage its finances prudently,” Murphy wrote in the year’s financial report.
Earlier this month, Federal Reserve Chair Janet Yellen suggested that the central bank could increase interest rates “relatively soon” in her testimony before Congress’ Joint Economic Committee. The Federal Open Market Committee that determines a target range for interest rates is slated to meet in Washington, D.C., on Dec. 13 and 14.