Most public pension funds around the country at the municipal and state levels are massively under funded. (Under funded means that Fund assets are below actuarial mandated Net Present Asset levels to meet future pension liability payouts.) Fund payout liabilities are overwhelming diminished asset values from a Bear stock market trend and low investment income on US Government debt securities.”… a common observation published almost daily on pension blogs and principal news-wire services.
The most recent headline of “maximum impact”, the Tsunami of pension under funded headlines, comes from Wharton’s Olivia S. Mitchell,
State Budget Woes Create a Black Hole for US Stimulus Funds
Today’s sudden shortfall of state revenues threatens not just new pet programs but also timeworn government promises, such as state pension plans. “The long-term obligations are coming home to roost,” says Wharton insurance and risk management professor Olivia S. Mitchell. Even before the recession, state pension plans were under considerable strain due to an aging government workforce, Mitchell notes. But the stock market crash sent state pension funds into a tailspin by reducing asset values by 25 per cent to 35 per cent. Public pension promises are now about $3 trillion underfunded, says Mitchell. That means states, just like individual investors trying to rebuild their 401(k) plans, need to set aside more money to make up losses. See Michell’s comments.
My opinion on this is that a Massive Problem ($3 Trillion) requires a Massive Solution to mitigate a Massive Collision….A $3 Trillion deficit will take huge State and Municipal contributions to cure current under funding likely from tax hikes, plus cutting runaway pension benefits to retirees, and finally fostering better pension asset investment practices that yield higher annual income returns and not be so reliant on appreciation returns from common stocks, as Bill Gross of PIMCO admonishes.)
And, as far as anticipating a rip roaring economic recovery to crank stocks higher and replenish equity asset values in pension funds, Bill Gross of Pimco has recently spilled the proverbial “cold water” bucket on those expectations. He sees only 1-3% GDP growth going forward with the massive current unemployment, higher taxes and credit granting stringency that will limit most sectors on economic growth potential. This creates lower P/E multiples and depresses share price appreciation, that undermines a lasting recovery in common stock pension asset values. See Bill Gross article
Gross’s Highlights: “If long-term economic growth declines by 1½% (meaning we go into a 1-3% annual GDP growth rate) then (corporate) profit growth will (decline) as well. What do trillion-dollar deficits and the recent re-initiation of PAYGO government programs tell you about the future of corporate tax rates? They’re headed higher. (And likely corporate profit growth…lower.) The new normal will not be investor-friendly (Attraction of common stocks diminishes.) unless your forecasting dial is turned to “Pollyanna” or your intelligence quotient is significantly less than 100.”
“Investors (Pension fund portfolios.) who stuffed themselves on a constant diet of asset appreciation for the past quarter-century will now be enclosed in a cage featuring government-mandated, consumer-oriented fasting. “Non Appétit,” not ”Bon Appétit”, will become the apt description for the American consumer, and significant parts of the global economy, including the U.S. Because this is so, short-term monetary policy rates will be kept low for longer than cyclical norms, and the outlook for risk
assets – stocks, high yield bonds, and commercial and residential real estate will involve just that – risk. Investors should stress secure income offered by bonds and stable dividend-paying equities. Consumer Cuisinart consumption is a relic of the past.”
I believe an appropriate “takeaway” from Mr. Gross (And it is a very passionate opinion he rendered.) In this slow growth economy now, and in the foreseeable future, put your sights on “high annual income” rather that “high annual growth potential” on the assets you choose for your fund. Pension funds need to refocus their investment strategy towards higher yield income gains each year in order to meet annual retiree pension payouts…Potential capital gain appreciation on common stocks may not be a reliable expectation in the future.
Today’s Conclusions: We clearly see that a massive $3 Trillion under funded deficit exists in the state and municipal pension fund area. This is even too great for the Federal Government to bail out. This is ”Systemic Risk” all over again, perhaps similar to the banking credit crisis of about a year ago, where $800 Billion of federal money…TARP Funds…were created to mitigate that problem, which is still far from being solved.
I don’t think that the average US taxpayer is ready at this time of: high unemployment, crushed residential housing values, and deflated 401Ks to take on the added burden of a federal bailout of state and municipal pension funds. If you compare public sector pension funds, an entitlement retirement program for police, fire, municipal, state and teaching employees and let’s toss in legislators, who often can qualify to enjoy an early retirement at age 55 and at 70% of their highest last year’s earnings to typical social security retirement income of the average Joe Smith, there is a gigantic moral disparity.
Consider this: Non public sector employees work till age 66 say to receive a $24,000 per year SS benefit, and during their working career, pay 7% of income (FICA) into SS plus employer pays 7% into SS for total of 14%. In sharp contrast, public sector employees pay say 9% of earnings into their pension funds, perhaps only up to age 55 and then get 70% of top-year earnings for the rest of their lives as a pension. When public sector employees are given the opportunity to “Game” that system, they receive late stage employment promotions and higher jump-off salaries, so in fact many can qualify at department heads to get near $100,000 per year and 10 years sooner than SS recipients. It looks like there is a great unfairness in public sector versus private sector pension practices needing some major changes (likely overhaul) to public sector plans. And, it is the liability driven cost growth of the plan, compared to weak investment returns, that are creating the massive under funding.
For more perspective on runaway pension liabilities, please see ILL Senator Chris Lauzen’s comments at Jim Capo’s Blog on the Illinois public pension mess, were the Senator discusses the possibility of pension bankruptcy and lists the 100 top Illinois pensioners each collecting over $100,000 per year
In summary, my mission is not to try and help fix the entirety of the public pension fund problem. I’m focusing on one piece or segment of the situation….How can we safely and predictably increase cash flow or income rates of return on pension fund assets, so that at least “annual pension payouts can get back somewhere near the annual investment income (interest and dividends)”. It is within reach, and state investment Codes for Public Funds will need change…change in the direction to promote more focus on investments for high income, rather than the most recent ill-fated focus on appreciation assets like growth stocks and US Government bonds at low single digit interest rates. I believe Bill Gross is right on how entities like pension funds should change their investing ways to “higher predictable income from the potential of appreciation”. In the past, it was Bon Appétit with a long term bull stock market, now it looks like “Non Appétit” and a struggling economy in the foreseeable future.
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