Defined Benefit Pension Plans are, in many cases, a ponzi scheme. Current assets are used to pay current claims in full in spite of insufficient funding to pay future liabilities... classic Ponzi. But unlike wall street and corporate ponzi schemes no one goes to jail here because the establishment is complicit. Everyone from government officials to union bosses are incentivized to maintain the status quo...public employees get to sleep better at night thinking they have a "retirement plan," public legislators get to be re-elected by union membership while pretending their states are solvent and union bosses get to keep their jobs while hiding the truth from employees.
We even published a note several days ago entitled "Establishment Tries To Suppress "Dissident Actuaries" Explosive Report On Public Pensions," which pointed out that the American Academy of Actuaries and the Society of Actuaries killed a report that would have warned about the implications of lowering long-term expected returns on pension assets. Apparently the truth was just too scary.
Bill Gross has been warning of the unintended consequences of low interest rates for years, and reiterated his concerns to Bloomberg recently:
Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV. Public pensions, including the California Public Employees’ Retirement System, the largest in the U.S., are reporting gains of less than 1 percent for the fiscal year ended June 30.
To our great surprise, certain pension funds are finally taking notice. Richard Ingram of Illinois's largest pension fund recently announced that he would be taking another look at long-term return expectations noting that "anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality." Ingram's Illinois Teachers' Retirement System is only 41.5% funded and currently assumes annual returns of 7.5%, down from 8% in 2014.
We decided to take a look at what would happen if all federal, state and local pension plans decided to heed the advice of Mr. Gross. As one might suspect, the results are not pleasant. We conservatively assume that public pensions are currently $2.0 trillion underfunded ($4.5 trillion of assets for $6.5 trillion of liabilities) even though we've seen estimates that suggest $3.5 trillion or more might be more appropriate. We then adjusted the return on asset assumption down from the 7.5% used by most pensions to the 4.0% suggested by Mr. Gross and found that true public pension underfunding could be closer to $5.5 trillion, or over 2.5x more than current estimates. Others have suggested that returns should be closer to risk-free rates which would imply an even more draconian $8.4 trillion underfunding.
While it should be a substantial overhang for the economy, no one seems to care for now, and thus, we don't expect this issue to be addressed anytime in the near future. Certainly legislators have no incentive to address this issue now... the country's 15 million union employees may not be so happy about supporting their political candidates if they knew their retirement plans were insolvent... much better to let the system break in 20 years then fix it with a massive tax increase and subsequent taxpayer bailout after convincing the electorate that the problem was somehow created by top earners not paying "their fair share." After all, it's only $23,000 per man, woman and child.