Public Pensions vs. Reality

Andy Kessler has an insightful op-ed in today’s Wall Street Journal about public pensions.  Referring to the Chapter 9 bankruptcy filing of Stockton, California, he mentions that a large part of the problem is centered around the actuarial assumptions that most public pension plans like CALPERS (California Public Employees Retirement System) use to predict how much money they will have to pay the pensions that public employee retirees have been promised.

 It turns out that the California Public Employees’ Retirement System, or Calpers, is Stockton’s largest creditor and is owed some $900 million. But in the likelihood that U.S. bankruptcy law trumps California pension law, Calpers might not ever be fully repaid.

 

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So what? Calpers has $255 billion in assets to cover present and future pension obligations for its 1.6 million members. Yes, but . . . in March, Calpers Chief Actuary Alan Milligan published a report suggesting that various state employee and school pension funds are only 62%-68% funded 10 years out and only 79%-86% funded 30 years out. Mr. Milligan then proposed—and Calpers approved—raising state employer contributions to the pension fund by 50% over the next six years to return to full funding. That is money these towns and school systems don’t really have. Even with the fee raise, the goal of being fully funded is wishful thinking.

Pension math is more art than science. Actuaries guess, er, compute how much money is needed today based on life expectancies of retirees as well as the expected investment return on the pension portfolio. Shortfalls, or “underfunded pension liabilities,” need to be made up by employers or, in the case of California, taxpayers.

In June of 2012, Calpers lowered the expected rate of return on its portfolio to 7.5% from 7.75%. Mr. Milligan suggested 7.25%. Calpers had last dropped the rate in 2004, from 8.25%. But even the 7.5% return is fiction. Wall Street would laugh if the matter weren’t so serious.

And the trouble is not just in California. Public-pension funds in Illinois use an average of 8.18% expected returns. According to the actuarial firm Millman, the 100 top U.S. public companies with defined benefit pension assets of $1.3 trillion have an average expected rate of return of 7.5%. Three of them are over 9%. (Since 2000, these assets have returned 5.6%.)

Kessler argues that instead of 7.5%, the real number is probably more like 3.0%.  If that’s true, it is unlikely that these pension plans will be able to pay future retirees what they are expecting.

What can we take away from this?

For one thing, young (and even middle-aged) people today should be saving as much of their income as possible because when they get ready to retire, even if they work for some government entity, the likelihood that they will get the guaranteed pension that today’s retirees are getting is becoming less with each passing year.  A smart person said that something that can’t go on. won’t.  In the future, as in the past, we are going to have to depend more and more on ourselves.  You may want to get a financial check-up along with your physical check up to make sure that you have a bright future.

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