Can We Handle the Truth? Public Pensions Are Short on Cash

We are in trying times for sure when the good news about public pensions is that an independent study confirms a huge funding shortfall--and it's greeted with applause because at least pension managers haven't been hiding it.

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The good news is they are telling the truth. The bad news is that the truth really hurts.

That pretty much sums up actuarial firm Milliman’s view of the U.S. public pension system. In a recent report, Milliman found that public pensions have 67.8% of the funds they need to meet future obligations. In the arcane world of actuarial accounting, that is strikingly close to the 75.1% level that pension managers report.

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So it seems that pension managers are not trying to hide the shortfall, as future beneficiaries and others have worried. Their fear was that through unrealistic assumptions about future returns on investment and other accounting gimmicks, pension managers might be papering over just how bad the books look. Evidently they aren’t. But that doesn’t change the fact that public pensions are still woefully underfunded—and it could get a lot worse under new reporting guidelines set for 2015.

Milliman looked at the 100 largest public pension funds and determined that they have $1.2 trillion worth of unfunded liabilities—some $300 billion more than the industry reports. While that sounds like a lot of money, “it really didn’t move the needle,” Rebecca Sielman, the report’s author, told Reuters. That difference could result from extremely minor changes in certain assumptions about the future.

The pension funds that Milliman examined assumed a future median rate of return on investment of 8%. That is far higher than the actual median rate of return of just 3.2% during the past five years. Yet it is not far from what Milliman believes is the appropriate assumption—7.65%.

Given the current low-return environment, some critics believe the pension funds should assume just a 5.5% rate of return. Such an assumption would nearly double the shortfall, according to an earlier Moody’s Investors Service analysis.

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The shortfall echoes problems in the private pension system, where sub-par market returns are taking a similar toll. This summer, Standard & Poor’s reported that the companies in its S&P 500 stock index collectively reported that their pension plans had obligations of $1.7 trillion and assets of just $1.3 trillion. The difference of $355 billion was the largest ever. Over the last 15 years, the S&P 500 index rose at an annual rate of less than 5%–the worst 15-year period in half a century.

If market returns revert to historical levels, private pensions should recover because in general large companies have continued to make contributions based on that likelihood. The same cannot be said of public pensions, where states strapped for revenue are having a difficult time putting cash into their retirement system.

2 comments
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ifafinder
ifafinder

I am sure they will look to the private sector for their short fall

frankkeegan
frankkeegan

Please, the Milliman "study" is just putting makeup on the corpse of state and municipal defined benefit pension plans. Take a look at the latest data from Census on the Top 100 plans, representing 89.4% of "financial activity" through Q2 of this year. The data show Milliman's assumptions already are invalid. Even on the face of it, dropping the discount rate from 8% to 7.65% having such a dramatic impact on funding levels should tell beleaguered taxpayers and betrayed government workers everything they need to know. When you look at investment losses, negative earnings, total payouts and increased obligations as of Q2 you will see that in aggregate, public pensions passed a fiscal event horizon into a black hole of perpetual debt.

http://www.statebudgetsolutions.org/blog/detail/latest-data-show-public-pension-death-spiral-locking-in