Sustainability of State and Local Government Pensions

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Grt2bOutdoors
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Sustainability of State and Local Government Pensions

Post by Grt2bOutdoors » Tue Jul 16, 2019 10:09 am

Interesting paper released yesterday for a conference on Municipal Finance held at the Brookings Institute - July 15-16th. While I have not attended, I am on their mailing list. Here's the link: https://www.brookings.edu/wp-content/up ... 9.MFC_.pdf

What I find interesting about this report (lengthy - 70 pages) is they go through various scenarios of annual real rates of return to show viability of plans over the long term. The other interesting thing is many of the contribution rates are into the high teens percentage wise. If they are making those kinds of contributions, what does that say for what an individual should be making? The conclusion is many of the plans are not "in crisis" and depending on the real rates earned, many of them are sustainable far into the future without having to resort to drastic measures.

If you comment - please, please, please refrain from making political comments or statements.
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AlohaJoe
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Re: Sustainability of State and Local Government Pensions

Post by AlohaJoe » Tue Jul 16, 2019 10:16 am

Grt2bOutdoors wrote:
Tue Jul 16, 2019 10:09 am
The other interesting thing is many of the contribution rates are into the high teens percentage wise. If they are making those kinds of contributions, what does that say for what an individual should be making?
Sounds about right. In "Safe Savings Rates", Wade Pfau looked at how much people needed to save to retire based on historical market performance.

Image

He suggests 16% as a baseline savings rate.

garlandwhizzer
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Re: Sustainability of State and Local Government Pensions

Post by garlandwhizzer » Tue Jul 16, 2019 7:19 pm

This article from Charles Schwab is on a different but related topic, the safety of municipal bonds. Impacting the safety of municipal bond investments are the status of different local/statewide economies (growing or contracting?) and their demographic/population shifts (taxpayers moving in or out?). A contracting economy in concert with a shrinking population base may pose serious issues to meeting future financial obligations of state and local governments. In some cases municipal bonds may not be as safe in the future as they have been in the historically. For those who invest in munis this article may be worth reading.

https://www.schwab.com/resource-center/ ... ipal-bonds

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iceport
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Re: Sustainability of State and Local Government Pensions

Post by iceport » Wed Jul 17, 2019 8:24 am

FYI, the OP's link just doesn't work for me. Here is a link to the document that did work:

The Sustainability of State and Local Government Pensions: A Public Finance Approach

Additionally, here are links to an introduction, How bad is the state and local pension crisis really?, and a Q&A page, Are state and local pension funds really in crisis?.

I haven't read the brief yet, but the first Q&A reads like a breath of fresh air! Finally, some sanity is introduced into the discussion. Rather than cynically and simple-mindedly belting out enormous — and largely irrelevant — unfunded liability numbers that collapse decades of debt into a single year, the studied approach considers the cash flow requirements in an on-going basis and in the context of the size of the economy and other spending responsibilities.

Thanks for the notice!
Q: One often hears and reads about a “crisis” in state and local pension plans and anxiety about trillions of dollars in “unfunded liabilities” that exceed the plans’ assets. Your bottom line is quite different. Why?

A: Much analysis of state and local pension plans focuses on valuing the plans’ liabilities—benefits promised to retirees—and comparing those obligations to the plans’ assets (their portfolios of stocks, bonds and other investments). The gap between the present value of those liabilities and assets, known as “unfunded pension liabilities,” is often a huge and scary number, the size of which depends on the discount rate used to calculate the liabilities and the rate of return used to project growth in assets. In most cases, the implicit assumption behind these analyses is that pension plans should reduce this gap to zero –that is, they should set aside enough money today to cover (or prefund) all the pension benefits they’ve promised to pay.

We take a different perspective, gauging the fiscal sustainability of a sample of 40 state and local pension plans by looking at their cash flows over time and determining when (or if) they will require outside funding to meet their obligations. We then estimate the increased funding that would stabilize the pension plans in the long run—that is, keep their obligations stable measured against the size of the economy. The way we look at it, an unfunded pension liability is similar to a government having debt, and a government’s debt is sustainable so long as its size relative to the economy isn’t continuously increasing.
"Discipline matters more than allocation.” ─William Bernstein

SovereignInvestor
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Re: Sustainability of State and Local Government Pensions

Post by SovereignInvestor » Wed Jul 17, 2019 9:01 am

ThE issue affecting state and local government ones is same as multiemployer ones.

They don't mandate a discount rate to use so the plans use "expected rate of return on assets" to discount liabilities. Most plans use 7-8% returns which is way too high so it understates how much contribution is needed to fund them so the funding levels will be overstayed and they'll perpetually be underfunded.

If 50% on average is in fixed income with yields barely 3% (10Y note is 2.1% now), and half is in stocks with average historical return of under 500bps over treasury or about 7%, then lets be generous and say stocks return 9%. Include about 50bps management fee, then how can they use 7.5%-8% expected returns. Even generously assuming 9% return for stocks and 3% for bonds the return of 50/50 blend and 50bps management fee would be 5.5%. If we assume 7% for stocks then 4.5% is appropriate. Average plan duration is 15 years so overstated returns 300 bps often will overstate funding ratio 300-400bps often
That 80% funded plan may look okay but may truly below 50% funded under realistic assumptions.

Only single employer corporate plans have to use percscribed a rated corporate bond rate which is conservative and mandated under Pension Protection act. As a result most of these plans are well funded and shut down and frozen because they are expensive to fund with low returns now. That is the truth, pensions are expensive to fund when the half in fixed income only gets maybe 3% now instead of 8-10% back in the 1970s-1990s.

The governments and MEP plans don't seem to want to reflect that reality because then either employers would have to contribute more and that is less for wages, or the employer pays more and makes taxpayers unhappy, or the benefits would have to be cut. So they continue using unrealistically high expected returns to discount liabilities because then the problem only hits when cash flow is an issue which is often decades away.

They need to use realistic discount rates. Single employer corporate plans use A rated bond rate in the 3.5%-4% range recently. That may be too conservative, but I don't get how these plans get away with anything above 6%. It's fraudulent to promise a pensign with underpinning that stock market will return 13% every year indefinitely which is what a 7-8% return figure assumes.

I worked as valuation analyst for pension plans many years ago.

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jeffyscott
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Re: Sustainability of State and Local Government Pensions

Post by jeffyscott » Wed Jul 17, 2019 9:54 am

AlohaJoe wrote:
Tue Jul 16, 2019 10:16 am
Grt2bOutdoors wrote:
Tue Jul 16, 2019 10:09 am
The other interesting thing is many of the contribution rates are into the high teens percentage wise. If they are making those kinds of contributions, what does that say for what an individual should be making?
Sounds about right. In "Safe Savings Rates", Wade Pfau looked at how much people needed to save to retire based on historical market performance.

Image

He suggests 16% as a baseline savings rate.
I did an analysis for a low income, low spending son of about 30. A 15% savings rate, with 3% employer match seemed adequate based on assumption of equal spending each year. I used 3% real and a 3.5% withdrawal rate.

This was with SS benefits included, which in a way is effectively about another 10% of income that is paying for retirement. So adding it all up, it's about 28% for 30-35 years.

(Regarding SS tax, OASDI is 6.2%, but 0.9% is for disability and an unknown part of the remaining 5.3% is covering survivor benefits, so I arbitrarily rounded to 5% for just the OAI part and doubled it to include the employer share.)
Time is your friend; impulse is your enemy. - John C. Bogle

cheezit
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Re: Sustainability of State and Local Government Pensions

Post by cheezit » Wed Jul 17, 2019 11:50 am

iceport wrote:
Wed Jul 17, 2019 8:24 am
Additionally, here are links to an introduction, How bad is the state and local pension crisis really?, and a Q&A page, Are state and local pension funds really in crisis?.

I haven't read the brief yet, but the first Q&A reads like a breath of fresh air! Finally, some sanity is introduced into the discussion. Rather than cynically and simple-mindedly belting out enormous — and largely irrelevant — unfunded liability numbers that collapse decades of debt into a single year, the studied approach considers the cash flow requirements in an on-going basis and in the context of the size of the economy and other spending responsibilities.
The second link seems to assert that risk-free assets provide annualized 1.5% real returns. However, attempts to estimate the expected real return of riskless assets by using T-bills to measure the instantaneous risk-free rate and various methods (TIPS break-even inflation, averages of analysts' forward inflation expectations, and a few other methods mentioned in Swedroe's recent article) to estimate expected inflation give much lower numbers of between 0.2% and 0.7% annual real returns for riskless assets. I am curious as to how they came up with their number.

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dual
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Re: Sustainability of State and Local Government Pensions

Post by dual » Wed Jul 17, 2019 12:28 pm

The NYTimes presents a real world application of these numbers:

Puerto Rico’s Bankruptcy Plan Is Almost Done, and It Could Start a Fight


https://www.nytimes.com/2019/07/14/busi ... omesa.html
After three years of negotiations, Puerto Rico’s federal overseers are at last finishing up a plan to complete the restructuring of the island’s roughly $124 billion in debt. To resolve the biggest government financial collapse in United States history, they have had to untangle the island’s thorny finances, negotiate with creditors and figure out how to do it without endangering the livelihoods of retirees who rely solely on their pensions.That may have been the easy part.
The oversight board wants to cut back the amount paid to some of those who hold the territory’s debt while also giving an unexpectedly good deal to more than 300,000 workers and retirees,

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Michael Patrick
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Re: Sustainability of State and Local Government Pensions

Post by Michael Patrick » Thu Jul 18, 2019 8:58 am

I thank my lucky stars that I wound up working for the state in WI rather than my home state of IL. According to data from Pew, Wisconsin had the best-funded pension plan in the country. That can largely be chalked up to a) design of the plan, and b) the resolve to keep making contributions even through the recession:
Wisconsin is one of only 10 states that have paid their full actuarial contribution every year from 2007 to 2013 and one of just 12 that achieved positive amortization from 2014 to 2017.4 Despite incurring losses during the recession, the Wisconsin Retirement System (WRS) maintained total contributions between 2014 and 2017 that exceeded by 36 percent the amount needed to keep pension debt from growing, resulting in positive amortization of over $1 billion.

The WRS is also designed to distribute any costs of short- or long-term deviations from plan expectations among employers, employees, and retirees by sharing the cost of poor investment returns during market downturns, as well as the benefit of strong investment performance during upswings. For example, while an employee is working, contributions from employers and employees rise and fall equally in response to market conditions. Moreover, once an employee begins drawing a pension, cost of living adjustments (COLAs) are set using a conservative return assumption of 5 percent—well below the WRS’ long-term return assumption of 7.2 percent. This approach effectively builds in a margin of safety against the costs of market risk and volatility: Annual COLA increases for retirees are implemented only when earnings exceed 5 percent (which they have done in 23 of the past 33 years), and can be suspended or rescinded if funded levels drop below 100 percent.

JackoC
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Re: Sustainability of State and Local Government Pensions

Post by JackoC » Thu Jul 18, 2019 9:26 am

Grt2bOutdoors wrote:
Tue Jul 16, 2019 10:09 am
Interesting paper released yesterday for a conference on Municipal Finance held at the Brookings Institute - July 15-16th. While I have not attended, I am on their mailing list.

If you comment - please, please, please refrain from making political comments or statements.
I agree with your sentiment, if it were possible, but I'm not sure it is possible to remove politics from topics like this. Brookings itself has a certain political orientation. All the well known think tanks do now. This doesn't mean I reject their findings out of hand, and I am absolutely not criticizing you for posting this. But I'd want to see what say Heritage Foundation researchers thought about Brookings' methodology and findings here before concluding anything solid. And vice versa for a HF paper about the true state of public pensions.

The main relationship of this paper and issue to personal investing is the quality of muni bond credit. Obviously there's a more direct connection to personal finances if you are a defined benefit pension recipient or future recipient from a state/local govt, but in that case the solvency of your own employers' plan is much more important than the average. The average is mainly important to national muni bond fund credit. However, reasonably I believe, assuming that the general case here is a portfolio pretty to very heavy in stocks and relying on 'bonds' as a fall back the real issue seems to me is correlated tail risk. It's not what's 'probably' going to happen to public pensions and muni's. Probably they'll muddle through more or less, as most things do. Probably stocks will be the main contribution to positive return in the portfolio, if history is any guide. The problem isn't the expected outcome. It's the lower tail outcome where your 50-60-70 or whatever % stocks do very poorly for a prolonged period Japan style or worse. And if you think that's impossible why have those bonds? The fact you have them means you think that's possible. Then if the prolonged bad stock performance undermines muni credit via the pension issue, that would be a real problem. When you really need those bonds is when their quality might be undermined by bad performance of the stock market, via the state/local pension funds, mainly invested in the stock market.

I don't think this paper is intended to address that issue, although again assuming we accept its findings (which again I would not necessarily 100% without seeing what the 'other side' of political thinktankdom could muster as criticism) it would be somewhat relevant in saying the midpoint expected case is not dire nationally. Under certain assumptions...but ones which tend to get into politics. Because how public pensions are handled is a fundamentally political question.

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