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Moody’s Triples Pension Debt Estimates

As we follow the evolving story of collapsing public pensions, one of the trickiest issues is the lack of reliable estimates of future returns on investment. Many of the biggest offenders among pensions assume returns of 8 percent or higher. These numbers may seem reasonable by historical standards, but they’re hopelessly optimistic today. Even plans that have revised their estimates downward still project returns far above what most analysts expect. If these estimates don’t come through, taxpayers will be left holding the bag, and either pension payouts will have to shrink or other services, including education and law enforcement, will have to.

Unions have long claimed that these worries are mere alarmism, but now Wall Street is stepping in to say it, too: pension investment projections are far too high. A new estimate from Moody’s anticipates average pension returns of 5.5 percent rather than the traditional 7 or 8 percent investment projection. The result of this estimate is a tripling of national pension debt, from $766 billion to $2.2 trillion. This is a major increase, but many analysts believe that it is accurate, or at least more accurate than previous estimates. As Public CEO reports:

With a bond-based earnings forecast of 4.1 percent a year, instead of the 7.5 to 8 percent in use at the time, the debt or “unfunded liability” of the three state pension funds increased tenfold, soaring from the reported $55 billion to about $500 billion.

The use of the lower earnings forecast based on U.S. bonds, the Stanford students said, reflected the view of economists such as Novy-Marx and Rauh that risk-free bonds should properly be used to offset risk-free pension debt guaranteed by taxpayers.

As time goes on, the arguments of pension critics are getting more respectful attention. With Wall Street now firmly on their side, it will becoming even harder for pension managers and their union backers to dismiss critics and deny that there is a crisis. The numbers just don’t add up.

The question now is how voters will react. If the recent votes in San Diego and San Jose are any indication, the unions are on much shakier ground than they think.

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  • http://sugel.net/ Sugel

    However, when plan liabilities are calculated in a manner consistent with private sector accounting requirements, methods that economists almost universally agree are more appropriate, New Jersey’s unfunded benefit obligation rises to $173.9 billion. This amount is equivalent to 44 percent of the state’s current GDP8 and 328 percent of its current explicit government debt. This calculation applies a discount rate of 3.5 percent (the yield on Treasury bonds with a maturity of 15 years) to reflect the nearly risk-free nature of accrued benefits for workers. It is estimated if state pension assets average a return of 8 percent, New Jersey will run out of funds to meet its pension obligations in 2019. If asset returns are lower than 8 percent, they will run out of funds sooner. State actuaries estimate that under certain assumptions, New Jersey’s pension plans will run out of assets to make benefit payments beginning in 2013.

  • Anthony

    Public pensions generally need a standard method of looking at pension fund committed obligation and ability to service; however, the problem of public pensions has not been caused by public employees who receive pensions but by politicians who have made pension commitments without providing sufficient funding (in many instances).

  • SteveMG

    Via Media deserves a lot of credit for covering this issue despite the broadsides from the usual crowd (not that it would deter you anyway).

    Nobody “likes” having to reduce these pensions. A lot of good, hard working folks will have to endure some pain.

    But the alternative is far worse.

  • Kris

    “The question now is how voters will react.”

    How about: “If the unions sabotaged efforts to address this problem, then the unions can darn well deal with the consequences themselves.”

    Most uncharitable, to be sure. How distressing that these voters would put their own interests first! But whaddaya gonna do?

  • Constitution First

    Taxpayers have made it far too unaccountable for their elected representatives to promise the contents of another mans’ wallet.

  • thibaud

    “Via Media deserves a lot of credit for covering this issue despite the broadsides from the usual crowd (not that it would deter you anyway)”

    No one who understands finance disputes the fact that US pension funds by and large are badly-managed and hack-ridden.

    The issue here is what to do about it. Mr Mead’s preferred remedy is to starve the state, roll back regulations, and tell the good people to buck up, pray harder and rely on themselves – presumably with an assist from Jesus.

    Those of us who are aware of how the Dutch, Swedes, and Canadians manage their pensions suggest that the solution is more and better governance. The Dutch and the Canadians have aligned their revenues and their commitments.

    After the public sector unions, the biggest obstacle to a sane, prudent, eminently conservative course of action now is the Norquist brigade and other zealots who’ve hijacked the GOP.

  • Forbes

    I think the issue is better understood, not as “What is the estimate of the future return of the pension fund assets, i.e. 5.5% or 8%?”, but rather, look at the underfunding that has occured over the last 13 years when the market return has been essentially flat, and the retirement benefits (healthcare & pensions) accrued have risen.

    The underfunding is less a question of what the future shall bring, but what the past has wrought.

    Public employee pay increases have driven up retirement benefits, sweetened retirement benefits have driven up retirement costs, and pension asset returns have vastly fallen short of expected returns, further raising costs–all hidden from the taxpayer in the opacity of arcane pension accounting rules. Practices, had they been followed by private companies, would’ve resulted in shouts of scandal and fraud from analysts, shareholders, and the media–and all absent in the case of the government.

  • thibaud

    For the curious, here’s The Economist on how Canada’s funds achieve good returns with professional management:

    http://www.economist.com/node/21548970

    I don’t have links, but perhaps others can find a good summary of how the Netherlands manages to achieve solvency ratios for its pensions close to the 100% mark.

    Hint: the Dutch actually fund their commitments with a progressive tax system.

    Likewise, Sweden moved years ago from defined benefit to defined contribution.

    The issue here is just a subset of prudent public financial management generally. There are two reasons that we in the US have not achieved what our Canadian Dutch and Swedish cousins have achieved re fiscal sanity and prudence:

    a) union hack-dominated TweedleDee, and

    b) anti-tax zealot-dominated TweedleDum.

    A pox on both your houses.

  • Harry Schell

    By comparision, the private sector DB plans I audited in the 1980’s had to use about 4% as their ROR assumption. The Government Accounting Standards Board (GASB) is finally requiring (kinda) the use of more realistic rates as FASB required of private sector plans three decades ago, for municipal financial reporting for years ending after 6.30.13. Anticipate some nasty surprises.

  • eatingdogfood

    Time to get out of the Country; FAST !!!

  • Al Moncrief

    PROOF THAT COLORADO’S GOVERNMENT LIES: COLORADO PERA’S ATTEMPT TO STEAL FROM RETIREES.

    When I was young I held the belief that public service in the United States is honorable, that the United States of America was exceptional in the world, that governments in the United States, while flawed, deserved the respect of citizens.

    Now that I am old, I see that I was naive . . . that governmental entities in the United States will intentionally deceive to achieve their goals, and that over two centuries our soldiers have died for a country that will countenance, and even celebrate, base behavior on the part of its public sector instrumentalities. It saddens me, but if this state of affairs persists in the United States . . . Honor is dead.

    Some background . . .

    You may know that an entity of Colorado state government, Colorado PERA, is attempting to breach its public pension contracts with its retirees. Colorado PERA is attempting a retroactive taking, a “clawback” of accrued, fully-vested pension benefits that were earned by retired PERA members over decades.

    Colorado PERA public pension benefits include a “base benefit” that is set at retirement and a “COLA benefit” that adjusts pensions annually to compensate for inflation. The “base benefit” and the “COLA benefit” are set forth in Colorado statutes with identical force of law and legal status.

    In its attempt to breach retiree contracts Colorado PERA has created a contrivance. The contrivance that Colorado PERA is using is that somehow the “base benefit” is a contractual obligation, but the “COLA benefit” is not a contractual obligation, in spite of the fact that both pension benefits are set forth in law in an identical manner. What this boils down to is attempted, unabashed, theft by government.

    Whether or not Colorado PERA’s attempt to take fully-vested public pension benefits from PERA retirees is ultimately successful in the courts, one fact has been incontrovertibly established . . . Colorado PERA, as an instrumentality of the State of Colorado, is an organization that will lie to achieve its policy goals.

    This is a sad fact for the many employees of Colorado PERA, for the trustees that have served on the Colorado PERA Board of Trustees over 80 years, and for the thousands of PERA members and retirees.

    And now, the proof of the deceit . . .

    Colorado PERA has told us, in writing, that the PERA COLA benefit IS a contractual obligation of PERA . . . and then, after initiating their attempt to breach contracts, Colorado PERA has told us, in writing, that the PERA COLA benefit IS NOT a contractual obligation of PERA. Both of these statements cannot be true.

    Colorado PERA in a written document, to the Colorado General Assembly’s Joint Budget Committee on December 16, 2009 states that the PERA COLA benefit IS a contractual obligation of PERA:

    “The General Assembly cannot decrease the COLA (absent actuarial necessity) because it is part of the contractual obligations that accrue under a pension plan protected under the Colorado Constitution Article II, Section 11 and the United States Constitution Article 1, Section 10 for vested contractual rights.”

    Link:

    http://www.kentlambert.com/Files/PERA_JBC_Hearing_Responses-12-16-2009_Final.pdf

    Colorado PERA on page 23 of its May 6, 2011 “Reply Brief” in the pension case Justus v. State states that the PERA COLA benefit IS NOT a contractual obligation of PERA:

    “Plaintiffs seek to create a contract right that has never existed—an unchangeable COLA for life triggered (inconsistently) by either the date of their retirement or ‘full vesting.’”

    Link:

    http://saveperacola.files.wordpress.com/2011/06/2011-05-06-pera-defendants_-reply-in-support-of-summary-judgment.pdf

    That is simply unbelievable.

    In one document PERA writes “the contract right has never existed.” In the other they write that the COLA benefit is a contractual obligation protected under the Colorado and US constitutions.
    When PERA writes that they need “actuarial necessity” to take the COLA benefit, they are not denying that it is a contractual obligation, in fact, it is an admission of the contractual nature of the COLA benefit.

    For further information regarding Colorado PERA’s attempt to take fully-vested pension benefits from retirees visit saveperacola.com or Friend Save Pera Cola on Facebook.

  • SteveMG

    Sorry, Thibaud, I’ve been reading Via Meadia since its beginning and there’s never been a proposal to, as you claim, completely do away with these programs.

    Completely?

    Perhaps I missed that?

    Instead of responding to non-existent arguments please try to respond to the ones being made.

  • CE

    What thibaud said.

  • Jim.

    Anything that can’t continue, will stop.

    So dies Blue.

  • don

    Of course, you didn’t mention that zero bound interest rates by the Fed to prop up insolvent banks and their bond holders doesn’t help the return on those pension fund investments. Seems to me one can either [lewd comment removed] the pension funds (and default on the social contract) or [lewd comment removed] the bond holders and make them default on their bond contracts (Isn’t that what’s supposed to happen during those moments of heroic capitalism?). What’s it gonna be, bub?

  • thibaud

    Steve – if Via Meadia stands for anything coherent, it’s the hostility to the notion of, as Mead puts it, “a strong, well- funded state.”

    His thesis, relentlessly propounded with tendentious references to the Drudge horror story du jour, is that government cannot provide a secure safety net to Americans.

    He contends that we can’t provide people with secure pensions; that we can’t offer a backstop of basic health insurance to all; that we cannot effectively regulate banks or industry.

    It’s a ludicrously over-the-top thesis, one that is daily undermined by events, but there it is.

    Take up your quarrel with him, not with the sane, moderate and _truly_ conservative voices who appear occasionally on these threads.

  • http://www.theparenttrigger.com Bruno Behrend

    Thibaud,

    We have a progressive tax system.

    http://taxfoundation.org/blog/no-country-leans-upper-income-households-much-us

    Greg Mankiw points out that there are two sides to “transfer payments,” one being the collection and the other being the dispensing of the money.

    We do well collecting scads of cash from the “rich,” but do a horrible job giving it away.

    http://gregmankiw.blogspot.com/2011/03/what-nation-has-most-progressive-tax.html

    Of course, you can point to our relatively low rates to argue we are less “progressive” than the EU states, but when it comes to actually getting money out of them, we do better.

    Frankly, the “rich” in high tax rate nations probably have 100s of ways to avoid the taxes. The better “redistribution” in these nations is most likely due to better/bigger “transfers” and a more stable tax system (VAT)

    Increasing taxes on the rich in American is idiocy. Phasing out all income taxes, corporate, and capital gain, while phasing in low, flat and broad national sales tax, financial transaction taxes, and BTU taxes would be a boon to the US.

    On the transfer side, phase out ALL transfers (Soc Sec, et al, and food stamps, Section 8) and just give every American $15K/yr indexed to inflation. Mandate that the first $5K go to health ins. and health and retirement savings.

    It won’t be utopia, but it will seem like it relative to today’s insane system.

  • http://www.theparenttrigger.com Bruno Behrend

    That stupid “emoticon” was supposed to be Sec. 8 (eight)

  • teapartydoc

    The way the countries Thibaud praises for their pension policies keep those policies afloat is by constantly importing workers to pay the taxes required to keep the systems going while the citizens of those countries continue to not reproduce. Sweden and the Netherlands will be unrecognizable in fifty years. This is government as suicide pact.

  • Jim.

    @Al Moncrief:

    The only option goverment had that would have led to an honorable solution was for someone to have the courage to say, back when COLAs were proposed, “I’m sorry, but we simply don’t know whether we will be in a position to keep that promise, years down the line. Automatic COLAs will not be applied to any state employee benefits”.

    Today’s public servants are no less honorable than yesterday’s; they are simply sadder and in an increasing number of cases a bit wiser.

  • felipe ramirez

    Pensions in us are bad because people receive more than they put in. They eat into budget. You can look at how much was promised it cost and then see how much it really costs. Always higher than projections. Posters like thebauld reverse cause and effect. Blame goes to politicians and those who support the unions. Just read all laws passed over years. That shows you is to blame.

  • richard40

    Sorry Thibaud, you are not going to convince me that we are undertaxed. But your points about the public sector unions and the politicians making unrealistic promisses and then underfunding them are good. But I dont beleive todays taxpayers should pay for their faults. Just pare back the pensions and health care to match the degree to which they actually ARE funded, and find a way to assume future returns so no future underfunding can occur. Perhaps the best way would be to give up the COLA and instead index these plans to a moving average of investment return, so they behave more like a 401k.

  • thibaud

    Again, contrary to the hallucinations and disinformation that routinely flood these boards, Sweden, Canada and especially the Netherlands all have progressive taxation, high-quality universal healthcare, and a well-funded strong regulatory state that reins in bankers – and their public pensions are in FAR better shape than ours.

    Again, Sweden for ex shifted from DB to DC many years ago. Sweden and Canada are both growing faster than we are and have done so for years. Their deficits are reasonable and their people enjoy a far higher level of protection than ours.

    It is simply an inversion of fact to keep suggesting that well-managed pensions and fiscal responsibility cannot co-exist with a decent safety net.

    If you think that we are _inferior_ to the Canadians, Swedes and Dutch, well, that’s a different argument.

    Not sure that many Americans will buy that one, though.

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