PENSIONS - State & Local Government Crisis
A $4.7 TRILLION STATE & LOCAL GOVERNMENT PROBLEM
REPORT: “Promises Made, Promises Broken 2014”
Market Valuation instead of "Discount Rates" based on Historical Investment Return Assumptions
WORST BASED ON "FUNDING RATIO"
WORST BASED ON "SIZE OF BAILOUT LIABILITIES"
WORST BASED ON "PER-CAPITA LIABILITIES"
State pension funds' combined underfunding rises to $4.7 trillion 11-12-14 Pensions & Investments
State employee retirement systems are underfunded by a total of $4.7 trillion for a funding ratio of 36%, said a report from State Budget Solutions, a non-profit organization advocating state budget reform.
The report, “Promises Made, Promises Broken 2014” uses data from fiscal year 2013 comprehensive annual financial reports and actuarial valuations from individual plans. In its 2013 report, the group estimated underfunding at $4.1 trillion, or a 39% funding ratio.
The report measured state public pension liabilities by market valuation instead of discount rates based on investment return assumptions because “the discount rates that plans use are just far too high,” said Joe Luppino-Esposito, State Budget Solutions general counsel and the report's author, in an interview. A risk-free rate based on a 15-year Treasury bond rate works better when states fail to make annual contributions and address unfunded liabilities, Mr. Luppino-Esposito said. “Even if you are on target, it doesn't work. The bottom line is that on paper nothing beats a government pension. But in reality, the money isn't there,” Mr. Luppino-Esposito said.
The overall actuarial assets of state pension funds in the 50 states, according to the report, total $2.68 trillion, while liabilities total $7.42 trillion.
Using the states' own assumptions, unfunded liabilities are just over $1 trillion, the report said.
The state with the lowest funding ratio is Illinois at 22%, the report said. The state's public employee pension funds have $95 billion in assets and $426.6 billion in liabilities, according to the report.
Enormous tax hikes for next 30 years needed to honor retirement promises to state and local employees - $5 Trillion Price Tag for Public Pensions 11-08-12
2010 CONTRIBUTIONS = 5.7% OF STATE BUDGETS
FUNDING REQUIREMENT = 14.1% or $1400/Household
As strapped state and local governments scramble for ways to balance their budgets, it's become very clear that it will be impossible for many to honor their pension promises to new employees and even current retirees. According to a 2010 DATA BASED study, the cost to fully fund these promises would cost taxpayers $5 trillion over a 30-year period, or nearly $1,400 a year in higher state and local taxes and fees for every household in the country.
Contributions to pay for public employees' retirement benefits now total 5.7 percent a year of all state and local taxes, fees, and other government charges. "Government contributions to state and local pension systems must rise to 14.1 percent" to produce fully funded pension systems, the study said, and it will take 30 years to get there.
Pensions 'Timebomb' - 85% of Pension Funds Will Go Bust 04-15-14 Goldcore
EARNING 4% OR LESS
ACTUARIAL ASSUMPTIONS OF 7-8%
The “pensions timebomb” keeps on ticking and as societies we become less prepared by the day. Yet another report shows that the public pension system is in dire straits. This one comes from renowned investment manager Bridgewater Associates.
Bridgewater Associates' Study
The study estimates that public pension funds will earn an annual return of 4% or less in the coming years due to near zero percent interest rates and financial repression. That, in turn, would cause bankruptcy for 85% of the pension funds within 30 years, the study warns.
Public pension plans now have only $3 trillion in assets to invest so that they can pay out $10 trillion of retirement benefits in coming decades, according to Bridgewater. The funds would need an annual investment return of about 9% to meet those obligations, the report says.
Many pension plans assume they will earn 7% to 8% annual returns, an assumption which is far too high. But even in the best case scenario of the pension plans achieving those returns, they will face a 20% shortfall, Bridgewater notes.
Bridewater looked at a range of different market conditions, and in 80% of the scenarios, the pension funds become insolvent within 50 years.
Rockefeller Institute of Government
A little notice report issued earlier this year by the Rockefeller Institute of Government says state and local government pension systems have very significant problems.
"Bad incentives and inadequate rules allowed public sector pension underfunding to develop," the study says. "They mask the true costs of pension benefits and encourage underfunding,under-contributing, and excessive risk- taking, trapping pension administrators and government funders in potentially destructive myths and misunderstanding."
It is likely that many pension funds will go bust in the medium term and this may be a crisis that looms large sooner than the Bridgewater research suggests.
Pension funds traditional mix of equities and bonds may under perform in the coming years. Many stock markets appear overvalued after liquidity driven surges in recent years. Bonds offer all time record low yields and are at all time record highs in price. They will fall in value in the coming years.
Public Pensions Are Still Marching To Their Death 09-11-14 Forbes
Public employee pension systems have long been a source of problems. State government politicians are continually tempted to underfund pension plans in favor of using that money for something with an immediate payoff. Those same politicians also tend to grant increased pension benefits to state employees because it is a simple vote-buying scheme with no immediate budgetary cost. However, a sign of how bad the morass of public pension funds has become is that most of them have become more underfunded in the past five years. If public pensions get more underfunded in years with positive stock market gains, what hope is there for their survival?
Morningstar considers a pension plan to be so underfunded as to be declared “not fiscally sound” if it is less than 70 percent fully funded.
According to Bloomberg, in 2012 there were 26 states whose pension plans met that standard. That is bad, but when you check the pattern over time, the trend is worse.
Of those 26 states in the most trouble, only one improved its funding status from 2009 to 2012. Yet those years were after the stock market drop of the recession and during a robust stock recovery. For the years from 2009 through 2012, the S&P500 index had a cumulative return of 71.1 percent. Obviously, public pension plans are not invested only in stocks and their returns were surely lower across their full portfolios. Still, one would have expected pension plans to be in bad shape in 2008-2009 at the market bottom, but to be in improved financial health by 2012 after the market bounced back.
If public pension plans are losing ground on their funding status in years when the market is delivering above normal returns, is there any hope for their survival?
The answer is probably not, but if there is a way to save public pension funds, it will require a new political calculus by the two parties most responsible for the current sorry state of affairs: state politicians and government employee unions.
In the current state of political compromise between (mostly Democrat) politicians and unions, politicians vote in favor of generous pension benefits for public employee union members and then union representatives accept under-funding of those pensions. This makes the generous pension benefits seem affordable by hiding the full cost of those giveaways.
- Politicians win because they avoid the spending cuts to popular programs or the tax increases necessary to actually pay for the benefits they voted for;
- Union leaders win because they can tell their members about the new pension benefits they secured.
Unfortunately, since nothing in life is free, a cost most be paid for these decisions. That cost is the higher probability the public pension fund will collapse under the weight of this under-funding and those public sector union members will lose their pensions.
The deals hinge on a key assumption in the calculation of the cost of any deferred benefit: the expected future return on the invested funds between now and when the benefits are collected. This future expected return on the pension fund investments controls how much money the politicians need to pay into the workers’ pension funds now. A higher assumed rate of return means less money is needed now thanks to all the money the investments are assumed to make in the future.
Right now politicians and union leaders are taking a huge gamble by using expected future rates of return that are much more optimistic than reasonable. The hope is that either investment returns will save the politicians from their irresponsibility and the workers from poverty or that the courts will force states to pay up enough later to keep their promises. Union leaders are accepting such a risk because they see the only alternative to be accepting smaller pensions.
NEW YORK CITY EXAMPLE
New York City’s pension funds are a prime example.
In 2000, the City’s pension funds were more than fully funded, sitting at 136 percent of what was needed and annual contributions were around $650 million per year, or 2 percent of the city budget. Today, New York City is paying $8 billion per year (11 percent of the budget), yet the funds now hold only around 60 percent of what is needed to be fully funded.
How could this happen?
- Poor investment returns,
- Optimistic expected investment returns,
- Longer lives in retirement, and
- Promises of more generous pensions for city workers.
If Mayor de Blasio agrees to more pension benefits for workers in his current union contract negotiations, the problem is only going to get worse.
So far, union leaders have agreed to this risky strategy of overpromising and underfunding, feeling safe in the strength of many state laws protecting public employee pensions from future cuts. However, Detroit’s bankruptcy case has shown a definite flaw in this strategy. If Detroit’s final plan involves pension benefit cuts, every public employee union will need to reassess their negotiating strategy.
Having politicians and union leaders conspire to reward public employees with generous pensions and then push the costs off onto future generations was never a particularly noble endeavor. It began and still continues today because both sides win from the deal, one in votes and the other in prestige and union dues. However, Detroit may finally show the hidden dangers in such a game.
If Detroit makes other cities and states face reality and adjust their pension plans to economic reality rather than political agendas, at least Detroit’s poor employees and retired workers will have done something positive for millions of other public sector employees out there. In the meantime, public sector employees and their union leaders need to make a hard choice: settle for realistic, smaller pensions that they are sure to collect or gamble on larger pensions that can only be paid for with well-above average future investment returns or by huge tax increases. Bigger pensions only look attractive until you factor in the risk of collecting nothing.
MORE FIDUCIARY FAILURE
Congress Quietly Passed A Bill That Seriously Messes With Corporate Pensions 08-13-14 Business Insider
The WSJ article details that:
Congress passed, and Obama signed, a transportation bill that happens to contain a provision to allow companies temporary relief from fully funding their pension obligations. In the fine print of the article we learn that the pension-funding obligation comes from calculations of current interest rates, which are extraordinarily low. What companies wanted, and our leaders delivered, was a pension-funding formula that took into account interest rates of the last 25 years, rather than the last 2 years. This is a key difference.
Here’s how I assume it works: If you observe that prevailing interest rates of, say, 10 year bonds are at 2%, then you have to make the assumption that all money invested in bonds for the next ten years will return just 2% per year. That’s reasonable. And from there you can calculate how much money you’ll have in 10 years, using compound interest. (see how I always work in a link to that idea?)
The problem is that if you assume only a 2% return on your money, then you need to invest a lot more money today in order to actually have enough to meet the future obligations of your pension plan.
If you could instead assume a bond rate of return of 6% – because that was the average interest rate over the past 25 years – then you need a lot less money to fund your pension plan. Problem magically solved. Companies are happy. CEOs are happy. Workers who depend on pensions eventually are unhappy. But hey! As Meatloaf says, 2 out 3 ain’t bad.
As I’ve written previously, the low returns of bonds are a major drawback of a low interest rate environment, when you have to have enough money for the long run. Endowments and charities and pensions that previously depended on a healthy bond portfolio to kick out 5-6% returns every year are stuck either generating less money for the long run, or they’re going far out onto the risky end of the investment spectrum (over-allocating to stocks or more exotic risks) to make the numbers work.
Or, as we saw yesterday, just pretend you can get the returns on bonds that we got over the past 25 years. Ignore our actual historically low interest rates now with magical-thinking assumptions.
By the way, what happens when companies underfund their pensions?
If a company disappears or goes bust, the federal government (and therefore you and me, via taxes) picks up the unfunded pension liability through an agency known as the Pension Benefit Guaranty Corporation. Just as the FDIC guarantees bank deposits (up to a certain size) and insurance regulators guarantee insurance payouts (when an insurance company fails), so does the PBGC pick up pension obligations when a private company with a pension goes bust. In 2010 for example, 147 companies with pension failed, and the PBGC paid our $5.6 Billion in liabilities to pensioners.
A big factor in the GM and Chrysler bankruptcy and bailouts of 2008, for example, had to do with the government pension guaranties.
For some time before 2008, GM and Chrysler had morphed from car manufacturers with large pension plans into giant pension-liability companies that also happened to make some cars (that not enough people actually buy anymore.)
I can’t claim to know the details of the agreement signed into law yesterday, but using tricks like a 25 year average on historic interest rates, rather than current interest rates, should keep us up all night, rather frightened.
This article originally appeared at Bankers Anonymous. Copyright 2015