We’ve spoken before on this blog about how woefully underfunded public pensions are.
This is because most pension funds are using unrealistically high rates of returns in their assumptions; assumptions that come nowhere close to reflecting reality.
But that piece was written more than a year ago; how do things stand now as at end-2017?
The bad news is that things haven’t improved one bit. And even legislators are beginning to wake up to this scary fact. ALEC, which stands for the American Legislative Exchange Council is, as their website description goes:
“The American Legislative Exchange Council is America’s largest nonpartisan, voluntary membership organization of state legislators dedicated to the principles of limited government, free markets and federalism. Comprised of nearly one-quarter of the country’s state legislators and stakeholders from across the policy spectrum, ALEC members represent more than 60 million Americans and provide jobs to more than 30 million people in the United States.”
And ALEC has released a report on the state of public pensions today titled “Unaccountable and Unaffordable 2017: Unfunded Pension Liabilities Top $6 Trillion”.
The report analyzed 280 state-administered pension plans using the risk-free rate of return as the discount rate, instead of the bogus figures most pension plans are using to deflate the actual value of their true unfunded liabilities. The risk free rate used was 2.142%, which was the average of US Treasury 10 and 20 year yields.
And what was the assumed rate of return the pension plans were using? Well, the average rate of return was an astounding 7.34%! It doesn’t take a genius to see that these figures are unrealistic in this low interest rate environment; hawkish Fed notwithstanding.
Using the more realistic rate of return, what the data reveals is disturbing. Here are some key facts and figures to pay attention to.
Total Unfunded Pension Liabilities – The report estimates that total unfunded pension liabilities stand in excess of $6 trillion. More disturbingly, this figure increased by $433 billion since the 2016 report.
Unfunded Pension Liabilities per State – Self-explanatory. Using the risk-free rate, California leads the pack by far with close to a trillion in unfunded liabilities.
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Unfunded Pension Liabilities per Capita – This shows the personal share of liability for each state resident. This shows just how severe taxes to be borne now or in the future would be. The highest figure in the nation goes to Alaska, with a staggering $45,689 per resident. See how the rest of the states stack up below. As an average across the nation, the figure is $18,676. Keep in mind that this figure includes children and the unemployed, so the figure among those actually paying taxes would be far higher.
Funding Ratio – A pension fund’s funding ratio is simply its current assets divided by its current liabilities. The higher this ratio, the better a pension fund can weather economic shocks. As the Government Accountability Office once testified to the Joint Economic Committee on the Pension Protection Act of 2006:
“Large private sector pension plans will be considered at risk of defaulting on their liabilities if they have less than 80 percent funding ratios under standard actuarial assumptions and less than 70 percent funding ratios under certain additional “worst-case” actuarial assumptions.”.
Unfortunately, this only applies to private, not public pension plans. Further, the minimum 80% funding ratio still falls far short of the guidance provided by the American Academy of Actuaries which has this to say:
“Pension plans should have a strategy in place to attain or maintain a funded status of 100 percent or greater over a reasonable period of time.”
So what’s the funding ratio like for state pension plans? As you may expect, the picture is bleak. Using the risk-free rate, the HIGHEST, Wisconsin, has a funding ratio is 61.5% while the lowest, Connecticut is a dangerously low 19.7%!
Conclusion
Public pensions aren’t sexy. It is in the interests of both politicians and fund administrators to keep using unrealistically high discount rates to cover up just how much trouble our state pensions are in. But intelligent investors know better, which is why they are diversifying their portfolio into assets that can act as a hedge and long term store of value, such as precious metals. And after reading this report, you know better too.
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