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Are We Underestimating Funding Shortfalls?
The Toronto Sun reports, Feds have $65B pension funding shortfall:
The
federal government has underestimated its employee pension
obligations, exposing taxpayers to a $65 billion shortfall, according to
a new report released Thursday by the C.D. Howe Institute.
Using
fair-value accounting, the measure used in the private sector and
based on solvency, the think tank calculated Ottawa’s net pension
obligation stands at nearly $208 billion. That’s $65 billion more than
reported in the public accounts.
The government lists its unfunded liabilities in the country’s national debt at $143 billion.
Taxpayers could be on the hook to back-fill the funding gap, the report by Alexandre Laurin and William Robson said.
On top of that, large exposure to public sector pensions could fuel fears of sovereign default driving up the cost of borrowing.
"The
larger-than-reported gap between federal pension promises in these
plans and the assets that back them is a problem, both for federal
employees and for taxpayers,” the pair said.
But
Canada is not alone. European and U.S. governments share the problem.
The United Kingdom for instance is facing a $1.8 trillion shortfall and
the U.S. has $3 trillion.
The difference, according to the
report, is that heavily indebted countries such as the U.K. have made
reducing these obligations a top priority.
Most federal
employees in this country have what’s known as defined-benefit
pensions, the most stable of all benefit plans since contributions are
fixed. And higher-income public servants often qualify for special
retirement compensation arrangements.
Backing promises to public
service workers, the RCMP and Canadian Forces would require
contribution rates of 35%, 41% and 42% of pay respectively, the report
says citing the chief actuary.
Actual contributions to these
plans today are 19%, 22% and 21% respectively. On average, two-thirds
of costs are borne by the government.
Leave
it to the C.D. Howe Institute -- a conservative think tank that
vigorously defends private sector interests -- to grossly exaggerate
the true state of public pension shortfalls. I went over their study, and it's based entirely on fair-value reporting of Ottawa's pension obligations:
More
importantly, the federal government arrives at the $201.4 billion
liability figure by discounting its accrued benefit obligations using
notional interest rates. One of these – a legacy from before April 2000,
when federal pensions were completely unfunded, and Ottawa needed a
benchmark to track its accumulating obligations – is the interest rate
on 20-year federal bonds for obligations arising from service before
then. The other is the expected return, currently about 4.2 percent in
real terms, on fund assets for benefits earned since April 2000. Neither
rate reflects current reality.
Deferred compensation is akin to a
loan from employees to the government – in this case, a loan indexed to
inflation and backed by taxpayers. For that reason, the best interest
rate for discounting the obligation is the yield on federal real return
bonds (RRBs). At the RRB rate on March
31, 2010 – 1.56 percent – liabilities for 2009/10 would have totalled
about $255 billion, as shown in the second column of Table 1.
The
final entry in the first column of Table 1, “unamortized estimation
adjustments,” is the portion of changes in asset values and liability
estimates, using the government’s accounting, not yet reflected in the
Public Accounts. The fair value column contains no such entry, because
fair-value accounting recognizes all such changes immediately.
The
government’s net pension obligation under the fair-value approach thus
stands at almost $208 billion – some $65 billion larger than reported in
the Public Accounts.
This raises the net public debt by an
equivalent amount. And, because the gap between reported and fair-value
pension obligations has grown over time (Figure 1), these adjustments
also change the annual budget balances. Since 2001/02, the Public
Accounts show the cumulative budget balances to be almost exactly zero,
with surpluses and deficits offsetting each other. The fair-value
approach to pensions, by contrast, shows a cumulative deficit over that
period of $72 billion. In 2009/10 alone, the annual deficit would have
been not the $55 billion reported, but $63 billion.
I
have a problem using the yield on RRBs to project future liabilities.
Moreover, fair-value reporting is sketchy, especially when you consider
where we are in the cycle and that private investments (private equity,
real estate and infrastructure) are not going to be valued fairly using
this method. The other thing to bear in mind is that most pension funds
do not have to sell their private investments any time soon, which is
another reason why relying solely on fair-value reporting grossly
distorts the true funding state of public pensions.
»
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Don’t you mean mis-underestimating?
It's tought to get an 11% return on stocks and 6% return on bonds when they yield 1.9% and 2.6%, respectively.
The most likely outcome is that equities will have a return equal to double their yield. Bonds might earn their yield.
So go ahead and assume a discount rate of 3.5% and tell me that there is enough money in the world to pay the liabilities of future pensioners in the developed world.
... because I don't think there is.
great article. "we've had a decade of underperformance which has not been factored in to the actuarial tables appropriately." Period. More to the point "in Canada as in Britain you have public health care." Try and budget that! If we're looking at a hyperinflation in the USA the consequences really are "far out, man"! Unlike the German or US Southern variant (post Civil War) this problem "cannot be contained." Just who are paying the taxes in the USA right now? Anybody? How about "the debts"? Again, "anybody"? Amazingly "the Fed has been at the forefront of throwing savers under the bus." Say again? "You don't want people who save but governments that borrow"? REALLY?
Perhaps you could show us an instance when using fair value actually exaggerated pension underfunding. Optimism is fine, but when you write articles about important subjects, we need facts and logic, not your ipse dixit.
It's all very simple. The "C.D." in the C.D. Howe Institute stands for Count Dracula. Properly translated from neoliberalese, the press release reads:
"Using fair-tooth blood-banking, the measure used by Wall Street vampires and based on Transylvaniency, the fang tank calculated the Ottawan peasants' net blood obligation stands at nearly 208 billion liters. That’s 65 billion more than reported in the Van Helsing accounts."
I remember reading a few articles and one on zerohedge I believe about Canada not having the same problems as the US. This really shines a light on their pension system. If they think that they will get help from the UK, the better think again. Eventually this whole pension scheme is going to come apart and people will see how much they have been conned (even the ones getting pensions right now).
Most of the public pension funds here in the US assumed RORs from 7.5-8.5%; in reality they are achieving far, far less. So, going forward, it's going to be even worse.
Underfunding?
That's one of the most understated descriptions I've ever heard.
Most public pension funds' projected liabilities are assumed calculating discount rates far too high, thereby diminishing the net present values. Utilize far too low inflation assumptions asto future benefits (COLAs, etc.), assume relatively static wages in the projections, underestimate future negotiated benefit increases, and assume far too high of estimated returns on assets (probably a significant portion of which are being carried at never yet written down values) and likely do not reflect the full impacts of leverage as has been applied to numerous asset classes.... amongst a veritable plethora of other additional errors of omission and commission.
Now, for anybody vaguely familiar with net present value calculations (And damned well better be if involved even tangentially in financial decision making and valuation, say as bond pricing being a simplest example thereof.) even very small changes in a single discount rate can have enormous impacts on an NPV so;ution.
But as noted above, we are not dealing in benefit land with one, but a dozen or so separate assumptions, each of which are generally not fudged by an insignificant amount, but substantially.
Thus, it is likely a gross understatement that benefit liabilities are literally, imaginarily understated.
My own professional opinion is that over the next several years, funding levels, contributions, discount rates and investment policies (oft poorly constructed by not the best and brightest in a money rich business environment overlaid by an oversight poor political process) will come to the fore, into the public spotlight, and promised benefits shall wind up being significantly curtailed.
The road to such will likely be painted by another firestorm of anger and retaliation by the taxpaying public of a magnitude similar to the ongoing bank bailout fiasco. Taxpayers are going to be very upset with their "public servants." Nay, all hell awaits. T'will be as if the Dogs of War were unleashed and will end badly, in tears. And so far, these numbers are not even included in the "you mean we owe what" commiserations. The public believes that public servants are in general, over paid, but have absolutely no idea of the magnitude of the bill they're being requested to pay.
It is good to remember that public servants are servants of the kleptocratic imperatives of the financial oligarchs. So, these derided souls do more to support free enterprise as it is now defined than almost anyone. roflamo at this tragicomedy, especially when the professionals, both ublic & private come to realize that their booty has simply been microplated like everything else these stalwart defenders of financial enterprise have touched.
Er...make that a magnitude GREATER to the bank fiasco. This time it really will hit home.
Leo we're broke you know that.....
having a bunch of public sector workers getting fully indexed, inflation, deflation proof vacations on my f'ng dime is perfectly fine with me..
I've got gold and they don't - so when the CDN is worth nothing more than a yankee buck then I'll laugh at them as I waive my precious in one hand and my middle finger int he other,
Look at this you miserable POS's - your 60K pensions are worth zilch.
WOOOHOOOOO!!!!!!!!!!!!!!!!!!!!!!!!!!!
Bitchez
Don't get me started...........
Where's my pill......................
Are we fucking kidding?
http://www.youtube.com/watch?v=5tthXGanBe8