Source: HardAssetsAlliance.com, by Shannara Johnson
Some experts think it will be the trigger for the next financial collapse. Others call it a “national crisis” of unprecedented proportions.
But what all of them agree on is that there’s no way US pension funds can keep their promises to the next wave of retirees.
Right now, millions of Americans are hard at work believing their pensions will be their saving grace for retirement. But the predicament pension funds across the United States find themselves in does not just spell trouble for the distant future.
The crisis is happening as we speak.
Though the challenges are well known by now, many believe that public-sector pension funds will be maintained and the gaps filled by strong investment returns, increasing employee contributions, raising taxes, or some combination of the three. They hope with these measures and ongoing strong asset returns, liabilities can be reduced and pensions salvaged. Unfortunately, this is wishful thinking at best.
Even though the facts are on the table, state and local governments continue to underestimate the crisis at hand. According to Hidden Debt, Hidden Deficits, a 2017 data-rich study of US pension systems by Hoover Institution Senior Fellow Joshua Rauh, almost every state or local government has an unbalanced budget—due to runaway pension fund costs that are continually chipping away at already inadequate budgets.
In 2016, Rauh stated, “while state and local governments across the US largely claimed they ran balanced budgets, in fact they ran deficits through their pension systems of $167 billion.” That amounts to 18.2% of state and local governments’ total tax revenue.
According to the 2017 report, total unfunded pension liabilities have reached $3.85 trillion. That’s $434 billion more than last year. Amazingly, of that $3.85 trillion, only $1.38 trillion was recognized by state and local governments.
The difference between funded levels under Governmental Accounting Standards Board (GASB) metrics and more realistic expectations reveals a massive amount of “hidden debt,” commonly referred to as unfunded liabilities. Under GASB metrics, public pension systems assume they will see annual returns of 7.5%. This assumption ignores the increased risks associated with stocks, hedge funds, real estate, and private equity to realize these returns.
Using that 7.5% annual return, unfunded liabilities for city and state plans are $1.38 trillion. However, when we use a more conservative return of 2.8% based on the Treasury yield curve, unfunded liabilities balloon to $3.85 trillion. Realistically, the truth probably lies somewhere between these two numbers, which still results in a huge increase in unfunded liabilities.
An Alternative Approach
Massive financial market losses in 2000–2001 and 2008–2009 led many pension funds to invest in high-fee and higher-risk alternatives such as hedge funds and private equity. But this strategy only exacerbated the funding gap over the past decade, failing to deliver expected returns.
The California Public Employees’ Retirement System (CalPERS) is one of the largest public pension funds with over $300 billion in assets and nearly 2 million members. After years of poor performance—including a meager 0.6% net return in the most recent fiscal year—the fund is now embracing a lower-cost, diversified investment approach, including exposure to gold.
Failing to meet its 7.5% return objective for several years, CalPERS recently has adopted a “Funding Risk Mitigation” strategy to meet the challenges of a maturing workforce, negative cash flow, longer life expectancies, and underperforming investments.
The facts clearly show that the states’ pension systems are on a losing track and retiree benefits are at risk of being slashed.
South Carolina: Canary in the Coal Mine
The looming pension fund crisis could leave already cash-strapped Americans without a safety net for retirement.
Take South Carolina, whose government pension plan covers around 550,000 individuals. One out of nine residents are invested in the plan… which is $24.1 billion in debt.
According to the Post and Courier of Charleston, government workers and their employers have seen five hikes in their pension plan contributions since 2012, and there’s no end in sight. And this isn’t an anomaly but the norm for many states throughout the country.
The worst-funded US state is currently New Jersey, closely followed by Kentucky and Illinois. By the end of 2016, New Jersey had a $135.7 billion deficit in its pension funds—$22.6 billion more than the year before—while Illinois’ gap grew by $7.6 billion.