Category Archives: Government workers and pensions

In the analysis of unfunded state pension liabilities, there are two main components: assets and liabilities. Here in Virginia, most attention is focused on the asset side of the equation — how much money have state and local governments set aside to pay for retiree benefits, and how well is the Virginia Retirement System managing the pension portfolio? Less attention is given to the benefit side — how rapidly are the liabilities increasing?

Wirepoints, a group that provides research and commentary on Illinois’ economy and government, has published a research paper arguing that the Prairie State’s massive pension liabilities are not the result of insufficient funding — asset growth has increased at an annualized rate of 5.9% from 2003 to 2015 — but of runaway increases in pension benefits of 7.5% annually. The difference: a 2.6% gap.

Many other states, including Virginia, have experienced the same problem of mismatched growth rates for assets and liabilities, though not to the same degree. Over the same 12-year period, Virginia’s pension benefits increased at a compounded annual rate of 6.3% while its assets increased by 4.2% annually. The difference: a 2.1% gap.

A few years ago, the increase in pension liabilities became a concern. Under pension reforms enacted during the McDonnell administration, state employees hired in 2014 or after were enrolled in hybrid pension plans, which combine a defined benefit plan with a defined contribution plan and an option for voluntary contributions. In essence the new package shifted some risk for funding retirement benefits from the state to the employees.

Thanks to the bull market in equities, Virginia’s asset performance has been stronger the past few years, and presumably the shift to a hybrid pension system has dampened the growth rate in pension benefits (and will continue to do so over time). Wirepoints’ numbers, based upon Pew Charitable Trusts data, goes only to 2015. More recent numbers might show more favorable trend lines.

Bacon’s bottom line: Growth in pension liabilities is one of the Virginia Retirement System metrics we should be watching. The onus for ensuring that the Commonwealth meets its pension obligations should not fall solely upon taxpayers and VRS portfolio managers. The state needs to keep pension costs under control, too. Legislators should check periodically to see if the hybrid pension plan is working as advertised.

Another year, and another analysis by the Pew Charitable Trusts on the deteriorating condition of U.S. states’ public employee pension plans. Drawing on data from 2016, Pew concludes that despite scattered actions by the 50 states to shore up their pensions, the funding gap only got worse.

In 2016, the state pension funds in this study cumulatively reported a $1.4 trillion deficit—representing a $295 billion jump from 2015 and the 15th annual increase in pension debt since 2000. Overall, state plans disclosed assets of just $2.6 trillion to cover total pension liabilities of $4 trillion.

There is considerable variability between the states, however. The funding ratio (assets as a percentage of liabilities) ranges from 99% for Wisconsin, which is in fine shape, to 31% for Kentucky and New Jersey, which are in deep doo-doo. The national average is 66%. Virginia is in modestly better condition than the national average with a funding ratio of 72%. Our net pension liability in 2016 was “only” $25.3 billion.

Admittedly, 2016 was a tough year in which state pension plans generated a mere 1% return on their investments, significantly short of the 7% to 7.5% returns that most plans are predicated upon. (Virginia assumes a 7% return.) Investment performance shined last year, which could improve 2017 performance when Pew gets around to calculating it a year from now.

However, investment returns are likely to become more volatile, Pew notes. As the gap between the return on 30-year Treasury bonds and equity returns has widened over the past two decades, pensions have shifted assets to riskier investments in the hope of generating a bigger payback.

The share of public funds’ investments in stocks, private equity, and other risky assets has increased by over 30 percentage points since 1990—to over 70 percent of the portfolio of state pension plans. As a result, pension plan investment performance now tracks equity returns more closely than bond returns.

That’s great news when the stock market goes up, as it did last year. But when interest rates rise and market multiples shrink, as is happening this year, pension funds are vulnerable to setbacks in stocks, private equities, and interest-sensitive real estate investments.

Pew has developed a set of analytical tools that allow a more penetrating look at a state’s pension posture. One of those is “net amortization as a percentage of payroll for each state.”

There are two ways for states to increase the assets in their pension plans. One is to earn a higher rate of return on its investment portfolio. The other is to contribute more (in employee contributions and government contributions) into the plan.

With the “net amortization” metric, Pew assumes that the pension plan earns the assumed rate of return (even though that assumption isn’t always justified). The idea is to determine whether state/employee contributions are putting in enough to cover new benefits earned that year. States the study: “Plans that consistently fall short of this benchmark can expect to see the gap between the liability for promised benefits and available funds grow over time.”

Some states are doing a horrible job — Kentucky, New Jersey, and Illinois are ticking time bombs. Kentucky paid in only 41% of its benchmark in 2016, and New Jersey only 33%. The national average was 88%. Virginia looked pretty good by comparison, paying in 101% and whittling down its net liability by one whole percentage point! Continue reading →

Many people get infuriated by President Trump’s many inconsequential falsehoods — does it really matter how big his inaugural crowds were? — but they remain sanguine about the trillion-dollar untruths that our public pension system is built upon. The big lie that governments will make good on retirement promises to their employees is not merely mendacious but it is destructive. Millions of Americans have built their retirement plans around a fiction. And when the Ponzi scheme collapses, government workers won’t be the only ones to suffer.

In his latest column, George Will recites some of the more glaring examples of how the big lie is unraveling.

The Dallas police and fire fund recently sought a $1.1 billion transfusion, a sum roughly equal to the city’s entire general fund budget yet still not close to what is needed. Last year Illinois reduced its expected return on its teacher retirement fund portfolio from 7.5% annually to 7% (which is arguably still too optimistic), meaning that the state needs to add $400 million to $500 more to the fund — annually. Last September, the vice chair of the agency in charge of Oregon’s pension system wept when speaking about the state’s unfunded pension promises of $22 billion. Nationally, unfunded liabilities for teachers, not counting other government employees, amount to at least $500 billion.

And don’t get me started on the fact that the Medicare hospital trust fund is expected to run out in only 12 years and Social Security trust fund in 16 years, at which point payroll tax revenues will be insufficient to maintain full benefits… Or the fact that the pensions run by companies in the S&P 1500 Index were unfunded to the tune of $562 billion.

Some of the shortfall can be attributed to absurdly generous provisions of pension plans in particular states and localities, some to fiscal indiscipline by government at all levels, and some to the Fed’s seven years of near-zero interest-rate policies that have depressed returns on bond portfolios and juiced stock market gains that cannot possibly be replicated in the years ahead.

Will concludes with the salient point:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

Few elected officials are willing to deal with the issue that offers no immediate political reward. Here in Virginia, one of the few, House Speaker William J. Howell, R-Stafford, has announced that he will not seek re-election.

Thanks in part to Howell’s stewardship, Virginia’s budget, backed by a AAA bond rating, is in better shape than those of many other states. But the U.S. learned after the 2007 real estate crash what AAA bond ratings are worth when the economy shifts from normal conditions to crisis conditions. Boomergeddon is coming. The only question is when.