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Old 01-09-2012, 11:34 AM
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Mary Pat Campbell
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Default Public Pensions Watch IV: the saga continues


New year, new thread, and I've got the perfect link to kick it off.

First, some housekeeping:

the original thread, started in Sept 2008 -

Second thread - Jan 2010 -

Third thread - Jan 2011 -

Okay, now a new post --- from Girard Miller in Governing Magazine:

One of my pet peeves in the ongoing debates over public pension reform is the way partisans on each side try to pitch half-truths and myths to support their arguments. The other side seldom believes any of these, but they help rally the allies on the speaker's side. Sometimes the press naively re-circulates these fallacies, which leaves the general public even more confused about what to believe. There's an old saying in politics that if you tell the same lie long enough, the public will eventually believe it — and that apparently is the mentality of lobbyists on both sides. In an effort to start the new year with a clean slate for public debate, I'd like to set the record straight on a dozen of the most glaring fallacies and silly slogans.

This is a lengthy column, so readers can click on to any one of these topics to jump to that subject:

1. "The pension mess was caused by greedy people (from the other side), not us."
2. "There's no crisis. The stock market will recover and then there is no problem."
3. "The solution is to replace pensions with 401(k) plans, like the private sector."
4. "Experts consider 80 percent to be a healthy pension funding ratio."
5. "Only 15 percent of pension costs is paid by employers. Investment income pays the lion's share."
6. "My pension contract is protected by the Constitution and can't be violated."
7. "States are already fixing the problem with reasonable pension reforms."
8. "The solution is collective bargaining. There is no need for drastic legislation."
9. "This is a $3 trillion problem when you measure it using honest (risk-free) math."
10. "We earned more than 8 percent in the last 25 years, and will do so again."
11. "The average public pension is $23,000."
12. The $100,000 pension club.
Go to the link for his comments on each "half-truth".

I'm just going to pull out one for this thread (others, feel free to pull out other points). We've got multiple threads on discount rates already, so let's go with the 80% funding level "half truth".

Half-truth #4: "Experts consider 80 percent to be a healthy funding level for a public pension fund."

This urban legend has now invaded the popular press, so it's about time somebody set the record straight. No panel of experts ever made such a pronouncement. No reputable and objective expert that I can find has ever been quoted as saying this. What we have here is a classic myth. People refer to one report or another to substantiate their claim that some presumed experts actually made this assertion (including a GAO report and a Pew Center report that both cite unidentified experts), but nobody actually names these alleged "sources." Like UFOs, these "experts" are always unidentified. That's because they don't actually exist. They can't exist, because the pension math and 80 years of data from capital markets history just don't support these unsubstantiated claims.

With only one rare and fleeting exception (which occurs at the very bottom of a business cycle, similar to the green flash in a tropical sunset), 80 percent funding is not a sufficient, sound or healthy funding level for a pension fund. The only authoritative references to 80 percent funding ratios are the federal ERISA and pension protection act provisions which require private-sector pension plans below 80 percent funding to take immediate remedial action! (Remember that public plans are not even governed by these laws.) These statutes do not make funding ratios at 80 percent "healthy" or "good" or "sound" or "well-funded." Pensions funded at 80 percent are no different than a $400,000 house in a distressed neighborhood with a $500,000 mortgage — you can keep living there if you keep making the payments, but it's underwater and your balance sheet is now upside down no matter how much you try to double-talk it. The only difference is that state and local governments can't mail in the keys to the bank.

Until the last recession, respectable and world-wise actuaries would tell you privately that when a pension system gets its funding ratio above 100 percent, there is a political problem. Employees, unions and politicians suddenly become grave-robbers who invariably break into the tomb to steal enhanced benefits and pension contribution holidays. So these savvy advisors historically have tolerated modest underfunding, based on their recurring past experience with the forces of evil in this business. They figured the ideal public plan would drift between 80 to 100 percent funding over a market cycle, and nobody would be hurt if the plans were a "little bit underfunded" in normal times. Obviously that didn't work out so well in the Great Recession, which has forced us all to take a harder look at the math and this conventional wisdom.

As I have explained in one of my very first Governing columns in late 2007 (when the last business cycle was peaking), a fully funded pension plan must today have market-value assets of 125 percent of current accrued actuarial liabilities near the peak of an average business cycle — in order to offset the near-certain loss of stock market values in the following recession. Historically, that is because the 14 recessions since 1926 (including the most recent) have shrunk equity values by 30 percent on average, and equity investments represent about two-thirds of the average public pension funds' portfolio. Real-time pension funding ratios will therefore likely decline by about 20 percent in the average recession, depending on how much the bond portfolio offsets the stock losses and mounting liabilities. So there is not a major public pension plan in the United States today that can be described as "overfunded."

A pension plan that is 100 percent funded at the end of a business expansion will likely lose 20 percent of its value in an average recession, so 80 percent is the bare-minimum "healthy" funding level at the bottom of a recession — and only then. Once the economy begins to recover, it is mathematically necessary for a reasonable funding ratio to be higher than 80 percent and rising on a clear path to full funding. Otherwise, the plan is doomed to be chronically underfunded with current taxpayers supporting retirees who didn't ever work for them. A plan funded at 80 percent going into a recession will likely find itself funded at 65 percent at the cyclical trough — and that's a toxic recipe calling for huge increases in employer contributions to thereafter pay off the unfunded liabilities. That's why today's 70 percent funding ratios are a legitimate concern and a financial burden on younger generations who will inherit this problem that their elders keep sidestepping.
Just think for one minute about what would happen if Europe unravels or China lands hard and we suffer another average recession from today's levels. That would take most pension funding ratios well below 60 percent percent and trigger a more horrendous multi-year budgetary catastrophe for public employers nationwide. Pension trustees and plan administrators with funding ratios at or below today's national average should be asking that question on the record in formal board sessions — if they understand how fiduciaries are expected to perform their duties.

One can argue that a pension plan with 80 percent funding today can be deemed prudently funded if it adopts a more aggressive amortization schedule that defrays its unfunded liabilities over the average remaining service period of incumbent employees. That's essentially what the GASB's proposed service-life amortization guidelines would ultimately imply. Anything less should invite suspicion and deserves serious reconsideration of the plan's funding policies and benefits levels. And if employees put skin in the game by agreeing to hereafter bear one-half the cost of paying down the plan's unfunded liabilities during their working years, we can then talk about 80 percent funding as a logically "healthy" or "sustainable" number.

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Last edited by campbell; 01-03-2013 at 10:53 AM..
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