public pension plan unfunded liabilities

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public pension plan unfunded liabilities

Post by larryswedroe » Fri May 06, 2016 3:51 pm

Unfortunately most of the picture is really ugly.
My colleague Jared Kizer looked at the issue http://multifactorworld.com/an-updated- ... n-funding/
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Re: public pension plan unfunded liabilities

Post by dmcmahon » Fri May 06, 2016 7:46 pm

Plan return assumptions probably need to be adjusted to the new normal of lower returns, especially on bonds.
But at least some plans are taking a hard look at overpaying for underperformance in hedge funds and other such vehicles - at last!

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Fri May 06, 2016 8:52 pm

dmmcmahon
No probably about it, public companies are REQUIRED to do so

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Re: public pension plan unfunded liabilities

Post by LadyGeek » Fri May 06, 2016 10:10 pm

Thread locked for moderator review.
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Re: public pension plan unfunded liabilities

Post by LadyGeek » Sat May 07, 2016 10:14 am

Upon further review, this thread will remain locked (not actionable).

Update: See below.
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Re: public pension plan unfunded liabilities

Post by LadyGeek » Sat May 07, 2016 3:04 pm

After receiving a PM, this thread is reopened to discuss actions investors should take in regards to bonds with high adjusted net liabilities.

This thread is now unlocked.
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sat May 07, 2016 3:21 pm

I believe that the information is very actionable. For example in our municipal bond buying programs on behalf of investors thanks to Moody's work we have stopped buying bonds in 9 states with very high adjusted net liabilities. Doesn't matter if individual bonds in a state are still highly rated because the state's condition could impact all municipalities and their ability to meet obligations.

I hope that this is helpful
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Re: public pension plan unfunded liabilities

Post by grabiner » Sat May 07, 2016 3:34 pm

If city pension plans have funding issues, that should be reflected in the price and ratings of the cities' municipal bonds. And this is a non-diversifiable risk; if pension assets (particularly stocks) fall in value, city pensions will have funding problems.

So this is another version of the same risk as high-yield corporate bonds. High-yield municipal bonds, particularly those for municipalities with underfunded pensions, are not good diversifiers for a stock-heavy portfolio. The story with high-yield corporate bonds is more familiar, given what happened in 2008, and the fact that high-yield corporates are more popular investments. (Vanguard doesn't even have a high-yield muni fund; Vanguard High-Yield Tax-Exempt holds mostly BBB bonds, which are considered investment-grade. It still lost 15% in 2008, compared to 27% for the BB- and B-rated bonds in High-Yield Corporate.) There is no free lunch in seeking higher yields.

There is also one other issue: make sure your munis are well diversified. You don't want to hold a lot of BBB-rated munis all from the same state, because those munis are subject to the economy of the state as well as the stock market.

For example, if you live in NJ, I would recommend not putting more than half your bonds in NJ Long-Term Tax-Exempt, which has almost as high a yield and as low a quality as Vanguard High-Yield Tax-Exempt. If the other half are in your taxable account, they could be in a higher-quality diversified muni fund such as Limited-Term Tax-Exempt (if you want an overall intermediate duration) or Long-Term Tax-Exempt (if you want a long duration). Alternatively, you could put the other half in a Treasury fund (either nominal or TIPS); this is particularly good in NJ because NJ exempts these funds from tax on capital gains, not just dividends. (This exemption applies to "qualified investment funds", which have 80% of their assets exempt from NJ tax.)
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Re: public pension plan unfunded liabilities

Post by nedsaid » Sat May 07, 2016 3:36 pm

This is a topic that should be discussed on this forum because some Bogleheads are probably State employees and participants in various retirement plans. The health of the public pension one is counting on would be a factor in asset allocation and savings rate. Were I a State of Illinois employee, I would be doing more saving and investing on my own. I would also plan that my promised pension could be cut by 50%. This is the reality that such people should be squarely facing.

The problem with these threads is that they get to be political. I am sure there is plenty of blame to go around and certainly the very low level of interest rates has a lot to do with this. There is a big difference if you can get 6% yield on safe bonds as opposed to the 2% or more you get now. This also contributes to pension plans being more aggressive with their investments to make up the yield gap.
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Re: public pension plan unfunded liabilities

Post by grabiner » Sat May 07, 2016 3:50 pm

nedsaid wrote:This is a topic that should be discussed on this forum because some Bogleheads are probably State employees and participants in various retirement plans. The health of the public pension one is counting on would be a factor in asset allocation and savings rate. Were I a State of Illinois employee, I would be doing more saving and investing on my own. I would also plan that my promised pension could be cut by 50%. This is the reality that such people should be squarely facing.
This is another example of avoiding investing in your employer. If your state pension might be reduced, you do not want to hold bonds from your state, despite any tax advantages, as they will decline in value if the state has to cut pension benefits. Instead, hold high-quality national municipal bonds.

It is less of an issue for federal employees; while federal pensions may be cut, there is no safe haven if Treasury bonds default. And federal employees can use the TSP G fund, which is immune to the risk of changing interest rates because the bonds mature daily.
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Re: public pension plan unfunded liabilities

Post by nedsaid » Sat May 07, 2016 3:53 pm

grabiner wrote:
nedsaid wrote:This is a topic that should be discussed on this forum because some Bogleheads are probably State employees and participants in various retirement plans. The health of the public pension one is counting on would be a factor in asset allocation and savings rate. Were I a State of Illinois employee, I would be doing more saving and investing on my own. I would also plan that my promised pension could be cut by 50%. This is the reality that such people should be squarely facing.
This is another example of avoiding investing in your employer. If your state pension might be reduced, you do not want to hold bonds from your state, despite any tax advantages, as they will decline in value if the state has to cut pension benefits. Instead, hold high-quality national municipal bonds.

It is less of an issue for federal employees; while federal pensions may be cut, there is no safe haven if Treasury bonds default. And federal employees can use the TSP G fund, which is immune to the risk of changing interest rates because the bonds mature daily.
Wow! Great point. You 'da man.
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Re: public pension plan unfunded liabilities

Post by iceport » Sat May 07, 2016 3:58 pm

nedsaid wrote:This is a topic that should be discussed on this forum because some Bogleheads are probably State employees and participants in various retirement plans. The health of the public pension one is counting on would be a factor in asset allocation and savings rate. Were I a State of Illinois employee, I would be doing more saving and investing on my own. I would also plan that my promised pension could be cut by 50%. This is the reality that such people should be squarely facing.

The problem with these threads is that they get to be political. I am sure there is plenty of blame to go around and certainly the very low level of interest rates has a lot to do with this. There is a big difference if you can get 6% yield on safe bonds as opposed to the 2% or more you get now. This also contributes to pension plans being more aggressive with their investments to make up the yield gap.
I agree with the first paragraph.

The problem is, pension under-funding is, inherently, political. Fiscal responsibility would dictate that revisions in expected returns would result in revised actuarial assumptions. Unfortunately, politics prevents that, because lowering the expected return assumptions (the responsible action) would require increased state contributions. In essence, the huge unfunded liabilities have arisen by willful neglect, not by accident of the market.
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sun May 08, 2016 9:32 am

Re political, no one needs to discuss the politics of the situation, just focus on the investment implications of the underfunding. That's safe ground.

It has implication certainly if you are an employee of one of the plan sponsors, and it has implications even if not--your state could suffer first from fewer services in future or even much worse, a Detroit like downward spiral as population that can leaves and you get a death spiral for cities and eventually states. So IMO it has very important implications for even where you might choose to live, assuming you have choices.

And it certainly has implication for investors, as we have chosen to avoid all bonds from weak credit states. Viewed as a pascal wager bet. The upside is very small extra return if bonds pay off, but huge potential loss for default. If I want or need bit more return I would rather simply extend maturity or tilt more to equity factors where at least potential rewards are much higher. Also my bottom line is that bond's role is to dampen overall risk to acceptable level, so I don't want to take credit risks which always show up at exactly the wrong time

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Re: public pension plan unfunded liabilities

Post by gasman » Sun May 08, 2016 9:46 am

larryswedroe wrote:Re political, no one needs to discuss the politics of the situation, just focus on the investment implications of the underfunding. That's safe ground.

It has implication certainly if you are an employee of one of the plan sponsors, and it has implications even if not--your state could suffer first from fewer services in future or even much worse, a Detroit like downward spiral as population that can leaves and you get a death spiral for cities and eventually states. So IMO it has very important implications for even where you might choose to live, assuming you have choices.

And it certainly has implication for investors, as we have chosen to avoid all bonds from weak credit states. Viewed as a pascal wager bet. The upside is very small extra return if bonds pay off, but huge potential loss for default. If I want or need bit more return I would rather simply extend maturity or tilt more to equity factors where at least potential rewards are much higher. Also my bottom line is that bond's role is to dampen overall risk to acceptable level, so I don't want to take credit risks which always show up at exactly the wrong time

Larry
Larry,

Given the investment implications of state and municipal finances, for a top tax bracket investor who has virtually all of their assets in a taxable account, are you comfortable keeping the lion's share of the fixed income in municipal bonds in this environment? (assuming of course that CD/muni rates or treasury/muni rates don't favor CDs or treasurys)

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sun May 08, 2016 10:55 am

gasman
I am not only comfortable it's what I am doing, just very careful to screen out the bad from the good, not throwing out the baby with the bathwater. We buy/ I Buy AAA/AA rated GOs and Essential service revenue bonds from the other 41 states. And we carefully monitor the credit rating and how the bonds are trading as well, and we sell if it gets to A with more than three years to maturity or if goes below that.
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Re: public pension plan unfunded liabilities

Post by iceport » Sun May 08, 2016 11:41 am

larryswedroe wrote:And it certainly has implication for investors, as we have chosen to avoid all bonds from weak credit states. Viewed as a pascal wager bet. The upside is very small extra return if bonds pay off, but huge potential loss for default.
Hi Larry,

Has a state ever defaulted? Or are you referring only to municipalities here regarding default risk?
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Re: public pension plan unfunded liabilities

Post by itstoomuch » Sun May 08, 2016 11:48 am

I wonder if an investor/saver be a, "debtor-in-possession" in a state/municipally/public service entity? joke. :?

I have said, "No Bonds", in our portfolio except thru whatever the annuities and small pension hold in their portfolio.

I had this conversation with older bro (Big Bank, TBTF, Risk management) in the 80's, concerning our state's modifying the PER to a guaranteed lifetime withdrawal benefit, like plan (GLWB). Essentially he said, "not on their radar, states have the power of taxation, don't worry-be happy." I was then trying to plant the seed that could modify his bank's behavior so that it [bank] could exert influence on the State/municipality/agency's behavior.

So decades later, I decided that it was better to emulate the PER plan rather than to fight it. Our, emulation represents about 20% of total retirement portfolio and closely matches our retirement's fixed expenses. :mrgreen:

YMMV :beer
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Re: public pension plan unfunded liabilities

Post by Valuethinker » Sun May 08, 2016 12:12 pm

iceport wrote:
larryswedroe wrote:And it certainly has implication for investors, as we have chosen to avoid all bonds from weak credit states. Viewed as a pascal wager bet. The upside is very small extra return if bonds pay off, but huge potential loss for default.
Hi Larry,

Has a state ever defaulted? Or are you referring only to municipalities here regarding default risk?
Does Puerto Rico count as a "state default"? My understanding is there is no legal basis for a state to go bankrupt, but I presume it could refuse to pay on bonds.

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Re: public pension plan unfunded liabilities

Post by Dirghatamas » Sun May 08, 2016 12:41 pm

iceport wrote:
larryswedroe wrote:And it certainly has implication for investors, as we have chosen to avoid all bonds from weak credit states. Viewed as a pascal wager bet. The upside is very small extra return if bonds pay off, but huge potential loss for default.
Hi Larry,

Has a state ever defaulted? Or are you referring only to municipalities here regarding default risk?
Hopefully my post will be NOT interpreted as political.

I would like to point out a key legal distinction between states and municipalities. US states are legally sovereign while municipalities are not. This is a very unique result of the United STATES being a federation. Many countries don't have this structure and their states are NOT sovereigns while ours are.

The key point is that legally a sovereign can't go bankrupt: that term doesn't mean anything in that case. Because a sovereign is the highest authority, it can simply refuse to pay its bond holders and they can't do anything about it. For currency issuing nation states, this is obvious. There is nothing behind the currency other than the nations will. A nation can simply print more money essentially defaulting by creating massive inflation (think Zimbabwe or Germany after first world war) or it can literally refuse to pay its foreign bond holders but not local ones (think Russia). Obviously, there are future economic consequences for such default, but for the past bond holders, there maybe no legal recourse, because by definition a sovereign is the highest possible authority.

States don't have their own currency so they can't default by creating massive inflation. However, they are sovereigns so they could literally pass a law saying previous bonds are invalid..yes there would be economic consequences but it is possible.

Municipalities are different. Because they are NOT sovereigns, they can only stop paying by declaring bankruptcy.

I personally take Buffett's views on risk seriously: nominal bonds issued by governments are likely more risky in the long term than the sum total of capitalistic businesses. I always hold 100% stocks globally market weighted.

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Re: public pension plan unfunded liabilities

Post by Oicuryy » Sun May 08, 2016 1:01 pm

The link in the opening post is just marketing hype from an investment advisory firm.

Those of you who have been sufficiently scared by that blog post can hire Buckingham to manage your municipal bond portfolio. Do-it-yourselfers who want to know which bonds to avoid can buy the Moody's report for $750 plus tax by following the link at the end of this press release.
https://www.moodys.com/research/Moodys- ... -PR_345741

The rest of us can just ignore the noise.

Ron
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sun May 08, 2016 1:03 pm

iceport, if my memory serves, yes states have defaulted, with the last being in 1933 and believe it was Arkansas. And I would add, even if something hasn't happened, doesn't mean it cannot or won't?

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Re: public pension plan unfunded liabilities

Post by Trader/Investor » Sun May 08, 2016 1:08 pm

Meanwhile in the real world have you seen the five year returns of some of the junk muni funds ala NHMRX and others? And all the while I have been hearing the academics and their dire forecasts of an imminent demise in that sector of the market.

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Re: public pension plan unfunded liabilities

Post by grabiner » Sun May 08, 2016 2:01 pm

Trader/Investor wrote:Meanwhile in the real world have you seen the five year returns of some of the junk muni funds ala NHMRX and others? And all the while I have been hearing the academics and their dire forecasts of an imminent demise in that sector of the market.
You miss the point here by using five-year returns. High-risk bonds will do well in good times, but poorly in bad times. In the last five years, there hasn't been a significant increase in risk; the only significant loss for any class of muni funds was an increase in rates in the summer of 2012.

Your example fund (Nuveen High-Yield Municipal Bond Fund) lost 45% of its value top-to-bottom in 2007-2008, almost as much as the stock market, and 38% in four months. The Morningstar average of high-yield muni funds lost 30% top-to-bottom, 25% in four months. High-quality bond funds (the Barclays index, or the Vanguard Long-Term Tax-Exempt fund which follows that index closely) lost only 12% top-to-bottom, and made up the loss within a few months.

And it is when the stock market falls that you most need your bond fund to reduce the risk of your portfolio; high-yield funds, whether corporate or municipal, didn't do that.
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Re: public pension plan unfunded liabilities

Post by iceport » Sun May 08, 2016 2:21 pm

larryswedroe wrote:iceport, if my memory serves, yes states have defaulted, with the last being in 1933 and believe it was Arkansas. And I would add, even if something hasn't happened, doesn't mean it cannot or won't?

Larry
Thanks Larry, good to know.

Your point is well taken about unlikely events, but my take is that this would have to be a truly black swan event, as was the Great Depression for AR. For any state already in fiscal trouble, defaulting on their bond obligations would certainly seem to be the figurative "nuclear option." The state would essentially be throwing in the towel on ever regaining any semblance of fiscal well-being, as the cost of borrowing — an essential tool for every state economy — would skyrocket.

Is that a fair assessment?
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sun May 08, 2016 3:38 pm

iceport
For what it's worth IMO several states will default, not if, but when and on what. It may be the bonds or it may be the pension obligations, but IMO almost certainly they cannot make their obligations. So no Black Swan will be needed. One example is I think it's one of Kentucky's plans is something like 15% or so funded. And Illinois is in desperate straights already not making many payments that they owe to businesses.

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Re: public pension plan unfunded liabilities

Post by btenny » Sun May 08, 2016 3:49 pm

If you do not have a 8 figure or 9 figure portfolio why do you care about individual municipal bond ratings and origin? I am confused. I just buy Vanguard Intermediate Term Muni bond fund and leave the bond selection to them. I use this "active" bond fund because I trust Vanguard and their fund manager to do this sorting and only select good bonds. Am I missing something? I have good deal of money in this fund and the shorter term fund.

Please advise.

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Re: public pension plan unfunded liabilities

Post by Hayden » Sun May 08, 2016 3:56 pm

btenny wrote:If you do not have a 8 figure or 9 figure portfolio why do you care about individual municipal bond ratings and origin? I am confused. I just buy Vanguard Intermediate Term Muni bond fund and leave the bond selection to them. I use this "active" bond fund because I trust Vanguard and their fund manager to do this sorting and only select good bonds. Am I missing something? I have good deal of money in this fund and the shorter term fund.

Please advise.
+1
I have 22% of my portfolio in the Vanguard Intermediate Term Muni Bond Fund. Should I be doing something different?

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Re: public pension plan unfunded liabilities

Post by Leif » Sun May 08, 2016 5:26 pm

Larry,

Since California has had its fiscal problems I've avoided municipal bond funds for California. Specifically, in the past I had investments in the Vanguard California municipal bond fund (VCADX). I sold those and instead I have concentrated on CDs which are generating taxable income. In your opinion are VCADX and VCLAX (Long Term) funds a good investment for someone in the 28% bracket given CA. high tax rate?

CA has the largest public pension fund, CalPers, currently funded at 77%. Is that a risk for the Vanguard investment?

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Re: public pension plan unfunded liabilities

Post by grabiner » Sun May 08, 2016 5:32 pm

Leif wrote:Since California has had its fiscal problems I've avoided municipal bond funds for California. Specifically, in the past I had investments in the Vanguard California municipal bond fund (VCADX). I sold those and instead I have concentrated on CDs which are generating taxable income. In your opinion are VCADX and VCLAX (Long Term) funds a good investment for someone in the 28% bracket given CA. high tax rate?
If you are in CA and don't want to hold CA munis, you might consider Treasury bonds or TIPS for your taxable bond holdings; these avoid the high CA taxes. (And you should definitely max out on I-Bonds if you hold any bonds in your taxable account; I-Bond interest is federally tax-deferred as well as state tax-free.)
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Re: public pension plan unfunded liabilities

Post by columbia » Sun May 08, 2016 5:44 pm

I had a modest (20K) in a state pension plan and rolling it over was an excellent investing decision. YMMV, but that particular plan appears to be in deep trouble.

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Sun May 08, 2016 5:56 pm

Cal is in a lot better shape actually then many others, but it's relative. I would be okay with buying certain municipalities within the state with very high ratings, say a Beverly Hills school district bond that was rating AAA/AA. And short term probably okay.

Hayden
Personally I would prefer the Baird fund, but at least the Vanguard fund is well diversified, but it buys credits we would not. So in times like 2008 it will underperform

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Re: public pension plan unfunded liabilities

Post by Leif » Sun May 08, 2016 6:26 pm

grabiner wrote:
Leif wrote:Since California has had its fiscal problems I've avoided municipal bond funds for California. Specifically, in the past I had investments in the Vanguard California municipal bond fund (VCADX). I sold those and instead I have concentrated on CDs which are generating taxable income. In your opinion are VCADX and VCLAX (Long Term) funds a good investment for someone in the 28% bracket given CA. high tax rate?
If you are in CA and don't want to hold CA munis, you might consider Treasury bonds or TIPS for your taxable bond holdings; these avoid the high CA taxes. (And you should definitely max out on I-Bonds if you hold any bonds in your taxable account; I-Bond interest is federally tax-deferred as well as state tax-free.)
But does TIPS have the phantom interest issue? You pay taxes in advance of realizing income from the inflation adjustment. I never considered holding them in taxable. I have considered holding a TIPS fund in taxable, at least they are paying out the inflation adjustment portion as a dividend.

Larry suggests selected individual bonds, but I would probably pay a high prices for those, since I'm just a small retail investor. I think when my CDs come due I will need to reconsider the Vanguard Muni funds.

Yes - I do hold I-Bonds.

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Re: public pension plan unfunded liabilities

Post by iceport » Mon May 09, 2016 6:15 am

larryswedroe wrote:iceport
For what it's worth IMO several states will default, not if, but when and on what. It may be the bonds or it may be the pension obligations, but IMO almost certainly they cannot make their obligations. So no Black Swan will be needed. One example is I think it's one of Kentucky's plans is something like 15% or so funded. And Illinois is in desperate straights already not making many payments that they owe to businesses.
Hi again Larry,

Wow! That's an amazingly bold prediction: Multiple states will default on their pension and/or bond obligations.

Certainly KY and IL are in rough shape. But you claim one KY pension fund is 15% funded. First, that's not exactly right, according to the 2014 data available from the folks at the Center for Retirement Research at Boston College. According to their data (again, updated to 2014), the worst funded plan stands at about 23.9% funded. Yes, that's dismal.

But it's also a little misleading. According to the same database, it's the smallest of the three "major pension plans in the state" reported, and accounts for only about 21.6% of the total pension liability. It's also important to note that that liability is not due this year, but is paid over the course of several decades. So the real question is, how much are the annual required contributions as a percentage of the total annual budget, or state economy. Measured in those terms, the situation cannot be nearly as dire.

In the spirit of full disclosure, I expect to replace roughly 30% of my income with a state pension after 30 years of employment. Therefor, I have a vested interest in finding and reporting accurate data.

On your side, if I'm not mistaken, you've articulated a fundamental philosophical opposition to any pensions at all, correct?
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Mon May 09, 2016 7:40 am

iceport
First, as I said was doing this from memory and in Kentucky case of the one fund I said something like. And I would note that the 2014 report is outdated and it has gotten worse since then. And yes it's the smallest of their plans. But there is IMO literally no way they will ever be able to make the payments promised. The politicians just keep kicking the can down the road as what happened in Detroit and eventually the can cannot be kicked.

So yes I do believe that at some point multiple states will default, now whether that is on their bonds or their pensions or some combination I have no clue. But I do know that if something CANNOT continue, it will not. It will come to an end, as it always does. My over 40 years of experience managing risks has taught that valuable lesson. And failing to understand that has led to disasters -including the failure and/or near failure of some of the largest banks in the world.

Anyone who thinks this is "noise" IMO is experiencing cognitive dissonance

As to philosophical differences IMO there should only be defined contribution plans (which can then be managed by professionals in standard plans with only low cost, passively managed funds) but never defined benefit plans because that puts all the risks on the taxpayers if the plans don't earn the expected returns.

Larry

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Re: public pension plan unfunded liabilities

Post by Boglegrappler » Mon May 09, 2016 8:10 am

As to philosophical differences IMO there should only be defined contribution plans (which can then be managed by professionals in standard plans with only low cost, passively managed funds) but never defined benefit plans because that puts all the risks on the taxpayers if the plans don't earn the expected returns.
Corporations have come to realize this is the case over the years. Buffett has a couple of sections in recent letters about this, and references an old report that he gave to Kathryn Graham of the Washington Post about the risks of defined benefit plans. Governments have been slow to move in that direction.

As far as the overall topic goes, the action --for those affected, and able to take it-- is to beware of the soundness of your pension plan if you're in a state that has a "heavy" can to kick down the road. This applies mostly to young people starting out. The second action available is that if you're a relatively well-off person, beware of owning property and remaining a resident of a state that is going to ask you to fix their problems. Again, its only actionable if you're retired, or otherwise geographically mobile. But for some, those choices are out there, and for some they are very important.

The implications for investors are fairly obvious. Always beware when looking for a higher yield.

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Re: public pension plan unfunded liabilities

Post by mengo » Mon May 09, 2016 9:10 am

larryswedroe wrote:. And I would note that the 2014 report is outdated and it has gotten worse since then.
Has it gotten worse, or is it just the update to GASB which introduced new accounting standards for pensions and was fully implemented recently (i think FY 15). I imagine the more recent increases in unfunded accrued pension liabilities is largely due to the GASB update.
For example a more conservative discount rate (20 yr Treasury) is now required to calculate the PV of any underfunded future years. Experts in the area probably do consider the recent changes, but I would like to know for sure if and how GASB 67 and 68 have been considered.

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Mon May 09, 2016 10:25 am

mengo
The problem is the states use "phony" discount rates to make the problem seem less. Corporations much less able to do so. This is why Moody's undertook the task to find out the true adjusted net liabilities, not the ones reported by the states
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Re: public pension plan unfunded liabilities

Post by celia » Mon May 09, 2016 12:34 pm

I think this is VERY actionable. But I haven't figured out the most effective action I (we) can take.
In many cases, this problem has been compounded by two issues: 1) state and local plans have not been accurately valuing the size of their liabilities, and 2) many state and local governments have not been making large enough contributions into the plan to cover the funding gap.
As a former public employee, I have seen many employees move up the pay scale while working for an agency so they can get not only increased pay but also an increased pension. The "problem" with the calculation of the pension benefit is that it is based on the employee's highest one year or highest three years of salary, while the premiums they paid were often for lower salaries for most of their working years. The premiums from the early years should be just as important (or more so) since they can compound until retirement but not enough is being contributed since no-one knows what the employee will earn 30 years in the future.

This is also a matter of fairness, in my opinion. Suppose there were two employees we will call Allen and Bob. Allen started at a low pay rate, but was a good learner, and took advantage of moving up the career ladder as openings arose. He ended his career as a Manager. Bob started with more education and hired in as a Manager. They both worked the same number of years and ended up with the same pay so are entitled to the same pension. Bob's premiums (and his employer's) pretty much cover his lifetime pension. But Allen's premiums (and his employer's) were much, much less. How is the pension fund supposed to calculate the shortfalls for all the future Allens coming up the pipeline?

To me, the solution is to have the pension be composed of a percent of each year's salary, not just the highest years. But how could one go about changing the formulas when the unions would never go along with it and it is spread over so many states and jurisdictions? Could anything else be done?
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Mon May 09, 2016 2:12 pm

btw-if you think this is not an issue, just consider the fate of some bond funds that owned lots of Puerto Rico bonds.
PR has proposed that GO holders get 74 cents on dollar, sales tax backed bonds get just 54 cents and development bonds get just 36 cents. ORMDX has almost 50% in PR bonds. But even some more conservative funds have 8-9% in them
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Re: public pension plan unfunded liabilities

Post by LadyGeek » Mon May 09, 2016 6:48 pm

The discussion is trending towards a general rant of the pension system, along with some politics.

Please stay focused on the investing aspects, which is deciding to invest (or not) in bonds with high adjusted net liabilities.
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Re: public pension plan unfunded liabilities

Post by jalbert » Mon May 09, 2016 7:15 pm

I think any public pension will have an annual actuarial audit of the pension assets and liabilities. I also believe that most states contract this out to an established respected actuarial consulting firm. It is thus surprising to me that the issue is being raised by Moody's, and not by the publicly available audits done annually on public pensions.

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Mon May 09, 2016 8:15 pm

jalbert
As I said the pension plans can set their own discount rate. Which of course if you choose a high one, your liabilities look low. Many are using discount rates of 8% or more, when even a 100% equity TSM portfolio would not give you that, let alone a typical 60/40 portfolio which would be more like 5 or so. They don't want to lower the rate because then they would look more underfunded and that would mean they might actually have to deal with the problem. Corporations cannot do this
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Re: public pension plan unfunded liabilities

Post by iceport » Mon May 09, 2016 8:26 pm

larryswedroe wrote:iceport
First, as I said was doing this from memory and in Kentucky case of the one fund I said something like. And I would note that the 2014 report is outdated and it has gotten worse since then. And yes it's the smallest of their plans. But there is IMO literally no way they will ever be able to make the payments promised. The politicians just keep kicking the can down the road as what happened in Detroit and eventually the can cannot be kicked.

So yes I do believe that at some point multiple states will default, now whether that is on their bonds or their pensions or some combination I have no clue. But I do know that if something CANNOT continue, it will not. It will come to an end, as it always does. My over 40 years of experience managing risks has taught that valuable lesson. And failing to understand that has led to disasters -including the failure and/or near failure of some of the largest banks in the world.

Anyone who thinks this is "noise" IMO is experiencing cognitive dissonance

As to philosophical differences IMO there should only be defined contribution plans (which can then be managed by professionals in standard plans with only low cost, passively managed funds) but never defined benefit plans because that puts all the risks on the taxpayers if the plans don't earn the expected returns.

Larry
Thank you for your reply Larry. I really do value your perspective, though in this case I'm not able to agree with it.

Your raise the specter of Detroit and Puerto Rico, but states, unlike municipalities and (apparently) US territories, cannot declare bankruptcy. Furthermore, it was reported that Detroit's pension obligations were *not* what brought down that city.

You talk about there being "literally no way they will ever be able to make the payments promised." That doesn't seem accurate, either. If required annual contributions amount to something like 5% or 6% of the annual state budget, that doesn't seem like the insurmountable problem you make it out to be. What am I missing here?
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Re: public pension plan unfunded liabilities

Post by iceport » Mon May 09, 2016 8:30 pm

larryswedroe wrote:jalbert
As I said the pension plans can set their own discount rate. Which of course if you choose a high one, your liabilities look low. Many are using discount rates of 8% or more, when even a 100% equity TSM portfolio would not give you that, let alone a typical 60/40 portfolio which would be more like 5 or so. They don't want to lower the rate because then they would look more underfunded and that would mean they might actually have to deal with the problem. Corporations cannot do this
Larry
In my state, and probably typically, the intent of using a higher discount rate is not to alter the perception of the liabilities, but to keep the annual contributions as small as possible — which is, of course, what allowed the unfunded liabilities to get out of hand to begin with. It's strictly an accounting gimmick used to help balance the budget every year. The lower the discount rate, the higher the required contributions.
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Re: public pension plan unfunded liabilities

Post by celia » Mon May 09, 2016 11:07 pm

LadyGeek wrote:The discussion is trending towards a general rant of the pension system, along with some politics.

Please stay focused on the investing aspects, which is deciding to invest (or not) in bonds with high adjusted net liabilities.
LadyGeek, I don't know if this warning is meant for me, but the title of the thread and the content of the original reference article talk about public pensions being underfunded. I also talked about that and how I think it came to be.

Many people so far are instead talking about whether or not to hold government bonds but the only association I see between that and the state pension systems is that the state (taxpayers) are usually responsible for pension shortfalls which could affect the state's credit rating, and thus its bonds.
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Re: public pension plan unfunded liabilities

Post by Tier1Capital » Mon May 09, 2016 11:48 pm

iceport wrote:So the real question is, how much are the annual required contributions as a percentage of the total annual budget, or state economy. Measured in those terms, the situation cannot be nearly as dire
Iceport is thinking about this correctly -- the % of state revenue spent on fixed costs (pension contributions & debt interest) is a good way to think about this concern. Beyond a certain % of revenue, fixed costs can crowd out basic government spending. A state may under-contribute to a pension plan for many years, but if plan assets are eventually depleted and the state enters a pay-go situation, this is when default risk rises. This is exactly what happened in PR a couple years ago when one of its pension plans restructured.

Hopefully my comments aren't interpreted as political. This is simply a way to think about the credit quality of state bonds. It's very similar to the debt-to-income ratio used by mortgage lenders.

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Re: public pension plan unfunded liabilities

Post by Tanelorn » Tue May 10, 2016 12:11 am

larryswedroe wrote:I believe that the information is very actionable. For example in our municipal bond buying programs on behalf of investors thanks to Moody's work we have stopped buying bonds in 9 states with very high adjusted net liabilities. Doesn't matter if individual bonds in a state are still highly rated because the state's condition could impact all municipalities and their ability to meet obligations.
Larry - for those wanting a simple tax-free investment, ie a single national muni fund that might not avoid this weaker credit states, how much dollar weighted exposure would we be taking to these poorly run states? Would you consider a straight taxable bond fund over a national muni fund for someone who was unwilling to try to avoid the worse states but for whom a muni fund would be otherwise appropriate?

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Re: public pension plan unfunded liabilities

Post by larryswedroe » Tue May 10, 2016 8:00 am

iceport
They don't have to declare bankruptcy to default. Don't know where you got that idea. States cannot declare bankruptcy, true, but they do default, have in past and will in future. IMO literally it's a certainty. The only issue is will they default on bonds or on the pensions. Illinois would already have done the latter but the courts ruled they could not. I'm rarely sure of anything, other than sun rising in east and setting in west, always careful to say my crystal ball is cloudy, but on this one I'm certain. Some states already make Greece look good and we know how that ended. This will end badly for some, and I see no reason to be one of them for a small incremental yield.
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Re: public pension plan unfunded liabilities

Post by larryswedroe » Tue May 10, 2016 8:06 am

Tanelorn, I would simply recommend either you buy your own bonds at auction, where at least you know you get the same prices as everyone, limit your purchases to what I recommend, GO and essential service revenue bonds and AAA/AA. And say max maturity of 10 years or so. It's what I did before we built our team. Also you can buy secondary market bonds from people like Vanguard or Fidelity with same characteristics. Or you can buy the Baird fund which is very high quality http://portfolios.morningstar.com/fund/ ... ture=en_US
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Re: public pension plan unfunded liabilities

Post by cusetownusa » Tue May 10, 2016 8:07 am

how does this information apply to NYS Munis? My wife is a teacher in NYS and our taxable bond fund is the Vanguard NYS Muni Fund. Would this be considered putting too many eggs in one basket? From my understanding the NYS Teachers pension fund is pretty well funded but I don't know much about the NYS Muni fund.

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