There is more negative coverage this week on public employment retirement systems, such as the Mississippi Public Employees Retirement System:
- Hidden Debt, Hidden Deficits: 2017 Edition, by Joshua Rauh; and
- The Unavoidable Pension Crisis, by Lance Roberts of Real Investment Advice.
Here are some excerpts from the Rauh report:
- “…the basic flaw in governmental pension accounting [is] the fallacy that liabilities can be measured by choosing an expected return on plan assets. This procedure uses as inputs the forecasts of investment returns on fundamentally risky assets and ignores the risk necessary to target hoped-for returns.”
- “In order to target high returns, systems have taken increased investment positions in the stock market and other risky asset classes such as private equity, hedge funds, and real estate. The targeted returns may or may not be achieved, but public sector accounting and budgeting proceed under the assumption that they will be achieved with certainty.“
- “What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire, but the accounting standards allow the bulk of this debt to go unreported through the assumption of high rates of return.”
- “That a 7.5 percent compound annualized return is wildly optimistic and unlikely to be achieved is clear to most observers of financial markets today.”
Meanwhile, Roberts’ report notes the structural problems of growing numbers of retirees and the inflated investment return assumption:
- “One of the primary problems continues to be the decline in the ratio of workers per retiree as retirees are living longer…”
- “The biggest problem, following two major bear markets and sub-par annualized returns since the turn of the century, is the expected investment return rate. Using faulty assumptions is the lynchpin to the inability to meet future obligations. By over-estimating returns, it has artificially inflated future pension values and reduced the required contribution amounts by individuals and governments paying into the pension system.”
- “However, the reason assumptions remain high is simple. If these rates were lowered 1–2 percentage points, the required pension contributions from salaries, or via taxation, would increase dramatically. For each point reduction in the assumed rate of return would require roughly a 10% increase in contributions. For example, if a pension program reduced its investment return rate assumption from 8% to 7%, a person contributing $100 per month to their pension would be required to contribute $110.”
Mississippi’s state government continues to ignore the PERS crisis. And yes, I’m calling it a crisis.
There are several scenarios for how this could play out and all of them except the ‘wish and a prayer plan’ are bad. If the stock market stays out of bear territory, at some point the funding shortfall will require workers to increase their contributions and the State to also kick in a bit more. That’s a best realistic case scenario.
The frightening scenario is that the stock market goes into bear territory sometime in the next 5 years and loses 20-50% of its value. If that happens it will be full freakout mode. It’s already happened twice during my 24 year legal career.