STUMP » Articles » Public Pensions: Why It's Important to Keep Watching » 25 June 2017, 06:41

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Public Pensions: Why It's Important to Keep Watching  


25 June 2017, 06:41

Something popped up on Timehop this morning that reminded me of something I posted three years ago.

Public Pensions: Why Keeping a Watch is Important:

While some pension plans are being sunk by hideous skulduggery, for the most part it is not intentional ill-will or underhanded dealing that has caused the problem of unsustainable pensions.

Some pensions that did what they thought they were supposed to — standard benefit designs with certain minimum years of service requirement, putting in the actuarially-required amount each year, investing in a mix of stocks and bonds with good oversight — are finding the required contributions are climbing rapidly and their funded statuses are falling behind. This is not a good thing.

Of course, many public pensions did not get their required contributions. Those fell even further behind. And continuing to fall further behind.

Even when the public employee unions are not to blame for the pensions being in a poor condition, it does no help pointing at all the “bad guys”, because said bad guys aren’t going to be coughing up the money. There’s no enough money from whoever the bad-guy-of-the-day is (or said bad guys died decades previously).

Ultimately, everything comes from the taxpayers: pension contributions and current salaries both come from the taxpayers. Those “employee contributions” to the pensions are from the taxpayers.

And you can only get so much from the taxpayers.

As noted above by Harris’s editor, would the public unions prefer for the media to cover what happened to the pension plans after they fail? Because some reporters have done that job elsewhere. And it did not call the pensions of Prichard, Alabama to come back into being. Fancy that.

There’s more, if you care to read it.

My conclusion:

Too many public unions think they can brazen it out, sue money for pensions into existence, and it will all be hunky-dory. Or that they can negotiate for pay increases now while waving hands at inadequate pension contributions, thinking that the pensions will always be made whole. Somehow. Eventually.

Funny how some still think they can sue the money into being. Good luck with that, y’all.


The thing is, I’ve been watching the public pension fiasco for a long time… but not as long as Jack Dean has at Pension Tsunami. And I know there are others who have remarked on this a long time ago.

Yes, this specific blog has been around only since 2014. But before that, I was at two blogs that no longer exist. But even before that, I started a thread at the Actuarial Outpost in September 2008. Here is the first post:

Public plans in trouble

I’m opening this thread so we can document various public pension plans that hit the rocky shoals. Via Instapundit, I saw this story on Cobb County, Georgia’s underfunded pension (shout out to my old town Marietta!)

“With about $349 million in assets and about $578 million in obligations, the plan is under-funded by about 40 percent, one of the worst ratios in the metro area. To meet acceptable standards, it must cut that rate to 20 percent, bringing assets up to about $464 million.
A nearly 4 percent loss on investments in the first seven months of the year and poor performance for three years at the start of the decade, more retirees leaving at an earlier age than anticipated, higher salaries that lead to bigger retirement packages and a longer lifespan for retirees are among factors forcing the changes, said Virgil Moon, the county’s director of support services and pension board chairman.

The industry standard for public employee pensions is a funding rate of 80 percent. Moon said the changes will put Cobb on a track to reach that in 20 years. Accounting standards for governments allow 30 years, he said.”

And here’s the Instapundit post. [the original link no longer works] I found this reader email interesting:

I teach Public Budgeting (aimed mostly at sub-state level budgeting) and have for the past 9 years in a Masters of Public Administration. You wouldn’t believe (well, maybe you specifically would) how many current or would-be local government employees have no idea how much money from the current budget it takes to fund future retirement benefits. It’s going to eat entire local budgets alive. I’ve been preaching this for the past nine years. Even a couple of my colleagues who should know better don’t usually address the problem much.

It takes a long time for these problems to come to fruition.

Much longer than it takes a company to run into trouble, and much much longer than it takes an individual to fall into financial trouble.

Part of the reason is the “taxpayer put” – yes, there’s a limit to how much governments can soak taxpayers, but they can increase the taxes over time until more and more people leave and then….

Another part of the reason is the “bondholder put”, which is exercised less frequently, and does a lot more damage when it’s exercised by politicians.

The biggest part of the reason is no oversight.


This exchange gives a hint:

Post by Fuzzy: [September 10, 2008]

Mary, I assume you’ve read at least some of these [link currently defunct]
How can they really say with a straight face that “governments don’t go out of business” (so they should be exempt from reporting MVL [market value of liabilities])? Or that reporting MVL automatically means not investing in equities?

Seems to me that if their actuaries put them up to to those statements, or participating in drafting them, that “the profession” may well deserve the beating that might come.

And my reply:

Well, I posted all these article links before reading those statements. (Quite a few to get through.)

Part of posting these various articles is to dispute that “governments don’t go out of business” argument amongst other arguments. There are various degrees of things that undermine that statement – I’ve seen towns unincorporate before (though usually small), but the failure of a public pension would come far before that. There’s no such thing as infinite taxing power. Even if they could tax 100%, there would be a limit on the amount of money that would bring in. But of course, well before that mark, people would just move away. I saw the idiotic “exit tax” idea in California (I would think that’s unconstitutional but IANAL), but really towns and states can’t keep people from leaving.

I am not a pension actuary. I do not know all the details in doing pension work. I do know theory, but I understand some people disagree with theory. These theory arguments can be futile, when we’re dealing with what-ifs that some people dispute could even come into being.

I want to (for now) stick to compiling what is actually happening in real life. What are the actual consequences of the funding decisions made (whether or not actuaries are involved in that), in the valuation of the liabilities (and if certain items are treated as if they were costless)…really nitty-gritty stuff of what the current state of practice has gotten us.

Note: this is before the big drop in the markets that year (which occurred September 29, 2008)

So that wasn’t my motivation — I wasn’t into the “MAYBE YOU SHOULDN’T HAVE VOLATILE ASSETS backing steadily growing pension liabilities” mode quite yet. But you better believe I hammered not only the asset drop from highly volatile portfolios, but also that the funds would be down (and paying out benefits) right when the taxpayers were tapped out themselves. So contributions dropped for many governments.


I can’t quite recall the timing, but this was around the time I left working at TIAA-CREF. While I did leave TIAA, it had nothing to do with the company itself — I love their products, and I kept my 401(k) there and rolled a different one into that account when I left another job. I just was looking for different opportunities. (“It’s not you, it’s me”)

At TIAA, I worked on their core product: Retirement Annuities — this is a fixed annuity product, and interest rates kept going down, down, down. This was hammering what we could credit to the annuities, and it had a huge effect on the amount in reserves and capital we had to hold to back up the annuity promises made. TIAA is a mutual insurer, so our primary goal was to maximize the retirement income we gave back to the annuity holders.

When I left TIAA, I had just finished a portfolio segmentation project that split the assets between the accumulation portion of the annuities (while the annuitants worked) and the retirement portion of the annuities (while they took income). I had multiple constraints to try to reduce a variety of risks (income volatility, solvency, etc) — it was a really interesting, but difficult project. I joked with people that if I had screwed it up, they wouldn’t know for 20 years.

That was a joke, by the way — because the segmentation was just a point-in-time project to get the ball rolling. I knew that others were also working on the project to handle transfers and rebalances monthly so as people retired, their accumulated balance transitioned from the accumulation bucket to the retirement bucket. Over us was our boss, and he had a boss, and the chief actuary was over that guy. Other people would be running the reserves, valuing the assets, etc. And somewhere up in the clouds was the New York state regulators who had their own queries that had to be responded to. Oh, and the rating agencies. I don’t think I ever ran into them (at the time).

Here is the thing — while I had some internal constraints on how I worked my project, the really overpowering constraints came from external parties: regulators and rating agencies.

Yes, regulators and rating agencies can fail, too (and I started an Actuarial Outpost thread about that).

But here’s the thing: he were required to value our annuity promises using mortality tables that reflected that annuitants tend to live longer than the general population; using discount rates that were far far lower than 8%; and if we wanted to use equities to back our annuity promises, we’d have to hold 30% of their value in capital, in reflection that these were volatile assets backing not-so-volatile promises.

And then I heard about public pensions.

TIAA’s clients are primarily universities, some of which are public universities. In a couple cases, I heard about the public pensions some of them participated in, and the TIAA product was an add-on for those faculty who wanted to save independently. I couldn’t understand how the DB pensions which were promising so much more could “cost” so much less.

I got angry a few times, because sometimes we were being asked to compete with the DB pensions as an option. I wrote a few intemperate letters to actuarial magazines (where very few people read them). I asked pension actuaries, when I could get a hold of some, why they thought they could discount at 8%.

I got the “government doesn’t go out of business” line more than once. Which made me really angry.

At the heart, I knew the promises being made were inherently expensive — I didn’t think that regulators were unfairly making insurers hold so much in capital and reserves for income annuities. But there was a huge gulf between the acknowledgment of the expense of making promises that can last for decades (my projections went out 100 years) and what public pension plans said their promises cost.

And then pension actuaries telling me that I shouldn’t worry about it, as if there were no consequences to low-balling pension cost.

I suppose it didn’t occur to them that thinking the pensions can’t fail made them more likely to fail.

We had seen disasters like that in insurance, and regulations were put in place after solvency failures to prevent similar failures. Insurance regulation is set up assuming that failure is always a possibility, and that the policyholders must be protected. The regulators get really angry themselves if they think you are being tricksy and trying to lowball your reserves or capital (and this is something that keeps popping up —
check out these search results)

The assumption has been that the promises can always be made good, because hey – it’s government! And government never goes out of business! (tell that to the Roman Empire – both the East and West – their military weakness partly stemmed from their financial weaknesses) We could always issue bonds! We could raise taxes!

Except the bondholders see it coming, and only so many are that desperate for short-term yield. And the taxpayers may take it for a few years, but once the companies move elsewhere, the people will follow….

And when the governments fail, driven by the public pensions that said governments were supposed to protect, where will the pensioners be?

Oh wait, you can ask the Detroit pensioners.

….Well, how could we see it coming?


Peter Drucker, noted management guru, wrote a book on pension funds back in 1976:


Peter Drucker’s revolution today


Peter Drucker’s 1976 book, “The Unseen Revolution: How Pension Fund Socialism Came to America,” was remarkably prescient. Decades ahead of his time, Mr. Drucker identified four factors that would determine the outcome of the “dramatic and far-reaching change” facing global pensions: (1) politico-agency issues, (2) pension contract and risk issues, (3) investment beliefs issues and (4) pension governance issues.

Although Mr. Drucker cautioned that his book was precautionary rather than prescriptive, he offered wise advice in each of these four dimensions nevertheless.
With the benefit of having watched the pension revolution’s actual 30-year unfolding, what can we say today about these five pieces of Mr. Drucker’s advice? The short answer is five-for-five. In other words, we now know that Mr. Drucker’s five pieces of advice, taken together, did indeed define the winning conditions for the coming pension revolution.

How well has the world heeded Mr. Drucker’s advice on winning the pension revolution?

Generally speaking, Mr. Drucker was far better at identifying the critical pension issues we would be facing and how they should be addressed than we have been at heeding his advice.

That’s an understatement.

I highlighted the politico-agency issues, because that’s the one thing public pensions just can’t get away from. The idiotic divestment campaigns, politicians determining the amounts contributed (and not pension trustees), politicians sweetening pension benefits – even retroactively – in order to get electoral boosts… basically, you can’t get the politics out of government pensions.

The 2005 article I linked to above holds up Dutch pensions as ideal, and they are pretty good in how they handled risk-sharing, governance, etc. I happen to think that the company TIAA does a pretty good job, too, but the kinds of promises made in its annuities was far more modest than public pensions make.

Another person who has long seen public pensions as a problem: Warren Buffet

BUFFETT: Here Comes ‘A Lot Of Bad News’ About Public Pensions

Mar. 1, 2014

Warren Buffett’s most important comments of late are tucked away in three paragraphs on page 21 of his annual letter to Berkshire Hathaway shareholders.

It’s a warning about public pension plans:

“Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford. Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them. Unfortunately, pension mathematics today remain a mystery to most Americans.

“Investment policies, as well, play an important role in these problems. In 1975, I wrote a memo to Katharine Graham, then chairman of The Washington Post Company, about the pitfalls of pension promises and the importance of investment policy. That memo is reproduced on pages 118 – 136.

“During the next decade, you will read a lot of news – bad news – about public pension plans. I hope my memo is helpful to you in understanding the necessity for prompt remedial action where problems exist.”

You may wonder why Buffett is warning private shareholders about government pensions.

I am not part of the Berkshire Hathaway tea leaves readers, and I leave it to others to discuss Buffett’s motives in 2014.

I will not question Buffett’s motives from 1975, as he very clearly lays out his issue with DB pensions, specifically for private companies. Given he buys companies as part of the Berkshire Hathaway strategy, and some have legacy pension promises, you can see his interest. It starts on page 120 of the PDF (numbered page 118). There’s so much good stuff over several pages, and you can see his concern there is inflation.

I want to pull out his conclusion:

Interesting how the specific financial concerns change over time. I may have been a toddler then, and not the owner of all sorts of financial knowledge (though I cottoned onto it by 1982), but this is what Buffett was looking at at the time:

There was a short spike of double-digit inflation at that time, and then a longer spate of inflation in the late 1970s/early 1980s.

Inflation drove a lot of financial policy for a while, including having DB pensions be based on final salary, as opposed to a career average. It drove automatic COLAs for Social Security and wage indexing. Buffett, in the 1975 letter, was good at pointing out that wording of the promises is extremely important, that seemingly small changes in the promise make huge differences in the actual value of the promises.


In any case, if you make promises that last decades, expect it to take decades for all the implications come forth.

Part of the reason to watch is so that people don’t say (though they will say) “How could we have known?” Buffett and Drucker were well-respected, as far as I can tell, back when I was a toddler, and even before I was born. They gave more than enough warning — and Buffett actually gets into some simple numerical examples to explain the risks. They said what needed to be done, they told you how it could have ended.

But it was easier to believe pretty stories of things always working out.

People will say “We could never see it coming! It came from nowhere!” But no, this is a slow moving disaster. Governments only pay notice when the money runs out. So that’s why I’ve started doing simple projections of when the money runs out.

Because it can.

Governments can go out of business.

Public pensions can get cut because the money has run out.

Failure is always a possibility. You may not opt for it, but you may not have an option after decades of making decisions that pushed the probability of failure closer and closer to 100%.

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