America’s Pension Problem

August 12, 2010

I recently read another interesting article from John Mauldin in his weekly newsletter, Thoughts from the FrontlineThis article focused on a report from the Center for Policy Analysis which indicates that state and local pension funds are drastically underfunded.  This is another one of those examples, such as the “shadow inventory” of home and condominiums, that foreshadows other major problems for our economy in the coming years.  

Essentially, the report argues that many state and local government pension plans’ liabilities are calculated using discount rates that are not commensurate with the risk they may pose to taxpayers. Accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds’ assets.  The reality is that most pension plans and their consultants assume they are going to get an 8% return on their investments. This at a time of a slow economic growth, very low bond yields, and a stock market that may be in for a long-term secular bear market.

Due to the use of these high discount rates, the liabilities of state and local government pension plans are underestimated.  The article notes a recent report by the Pew Center on the States and others that indicates pension assets will cover about 85%of the pension benefits owed to participants. Other studies that adopted lower discount rates have found liabilities may actually be 75% to 86% higher than reported. As a result, taxpayers’ role as insurer may be much greater than anticipated.

If the authors’ calculations are true, state and local pensions are underfunded by $3 trillion.

One of the graphs represents the reported unfunded pension and non-pension benefit liabilities for state and local governments as percentages of the states’ GDPs before adjusting the discount rate:

Seven states — Alaska, Connecticut, Hawaii, Illinois, Kentucky, New Jersey and West Virginia — have total unfunded pension and non-pension benefit liabilities above 15 percent of GDP.

Nine states have reported unfunded liabilities less than 2 percent of their GDP — Florida, Idaho, Iowa, Massachusetts, Nebraska, North Dakota, South Dakota, Tennessee and Wisconsin.

What is interesting is that only two states, Delaware and Florida have pension liabilities that are below zero (negative) as a percent of their states GDP (although Delaware has a very high level of Other Post-employment Benefits).

This bodes well for those of us who live in Florida as a place to retire.  Many other states are on a collision course since pension funding will soon consume 25-30% or more of their tax revenues.

Full Article

Posted by Scott R. Lodde

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