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You are here :Home Risk To Reward Public Pensions Are Woefully Underfunded: Which State Will Be The First To Go?

Public Pensions Are Woefully Underfunded: Which State Will Be The First To Go?

December 2, 2016

If you are a public employee, how much trust do you have that your pension plan will be able to pay you what is owed when it is due?

If you have been following the news, you may have heard some talk that state pension plans are underfunded, but do you really know the full extent of the situation? Here’s the reality, every single state has underfunded pension plans, with California and Alaska leading the pack.

Pension chart

Pension data in California is particularly easy to track, thanks to the efforts of the Stanford Institute For Economic Policy Research (“SIEPR”) which maintains a handy database known as the Pension Tracker.

Based on 2015 data in the database, which has been analyzed by the Kersten Institute For Governance and Public Policy, California’s pension debt had a market value of about $1 trillion in 2015 or $92,748 per household. This figure is also expected to rise in 2016 to over $100,000 per household; for reference the pension debt per household stood at $77,700 in 2014, an increase of 11.9%.

The Kersten Institute is not the only one sounding the alarm bells on public pensions; in the middle of the year, bond king Bill Gross warned that funds who have been counting on returns in the 7 to 8% range may need to halve their expectations to about 4%. His final conclusion? Gross says:

Pensions have to adjust, they have to have more contributions and they have to reduce benefit payments.

In the current low interest rate environment, pension funds have been struggling to meet the returns required to fund their liabilities, with ratings agency Moody’s estimating that the unfunded liabilities of the various federal employee pensions systems, covering civilian and military employee benefits, amount to about $3.5 trillion, or 20% of US GDP. The report continues:

Historical precedent suggests that it is unlikely that the federal government will offer significant financial support for distressed state and local government pension plans.

Translation: while the big banks on Wall Street are justified in receiving taxpayer funded bailouts, since they are too ‘systemically important, all you people who dutifully served the government in the expectation of a reasonable retirement can forget about it.

Of course, lowered projected rates of returns on these funds would mean increased contributions, resulting in a contagion effect from other local municipalities. Take a look at the case of the California Public Employees’ Retirement System (“CalPERS”) which within the next couple of months will have to decide whether or not they should lower their long term assumed rate of return from 7.5% to 6.0%. To put those figures into perspective, CalPERS rates of returns for the past two years stood at 2.4% and 0.6%. As the report states:

CalPERS documents show that some governmental units could see their contributions more than double if the rate of return was lowered to 6%. Mr. Hutchings said bankruptcies might occur if cities had a major hike without it being phased in over a period of years. CalPERS’ annual report in September on funding levels and risks also warned of potential bankruptcies by governmental units if the rate of return was decreased.

If the CalPERS board approves a rate of return decrease in February, school districts and the state would see rate increases for their employees in July 2017. Cities and other governmental units would see rate increases beginning in July 2018.

Things really aren’t looking good for the pension system; but what happens when pension funds start going under? As we have seen in the case of countries such as Greece and Venezuela, in times of financial crisis, bank runs are quite common and in those scenarios the banks and the government simply close down and prevent depositors from making withdrawals of their own hard-earned money.

This looks to be the case for the Dallas Police and Fire Pension Fund, which is not only chronically underfunded but also had to take a $1 billion write down from years of mismanagement and poor real estate deals, and have asked the city for a one time infusion of $1.1 billion. In the meantime, panicked retirees are making withdrawals en masse, and Dallas mayor Mike Rawlings recently called for an immediate suspension of lump-sum withdrawals from the fund.

Sound familiar?

While the Dallas retirees may have to endure a little short-term pain from the halt in redemptions, ultimately it will be the taxpayer, once again, who will be the long-term losers that will have to cough up whatever is required to support an unsustainable system.

All of this just illustrates the dangers of putting your eggs into one basket, especially if that basket is the government. Portfolio diversification is key to a successful investment portfolio, and long-term stores of value such as precious metals are great options to achieve this.

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