Tuesday, October 16, 2012

Expansion of "Illinois Teachers Pensions" Post of August 25 ... "Advice" for Public Sector Pension Recipients and Taxpayers

The road where (1) promised pension and 401(k) benefits are affordable and generous intersects with (2) a healthy stock market which is propelled by the performance of companies in a prosperous private sector with high employment levels. That in turn funds the public sector, retirement benefits included.

There has been a great deal of discussion lately about the ability to pay teachers and other public sector pensions in Illinois (other states and public sector employees, too) and the politicians' reluctance to come to grips and deal with the problem.

My take is simple. Unless teachers want to accept dramatically less than what they've been promised or taxpayers want to pay more than what they believed would be required, there is only one realistic answer --- invest pension contributions and funds almost 100% in stocks. If that approach were taken, taxpayers would be better served, as would teachers and other public sector workers, and it's quite possible that the currently looming catastrophe would be avoided.

Now let's look at the retirement benefits affordability problem as a whole across the U.S. and how to best be able to pay those benefits.

There is a tremendous disconnect between the reality of our nation's prosperity and the belief by many, fostered by far too many politicians and pundits, that investing in the private sector is somehow not in the best long term interests of the ordinary citizen, employee and taxpayer alike.

Wholly improperly, pension investments in stocks are deemed too risky and the erroneous assumption is made that a vibrant and healthy private sector stock market isn't exactly the engine that fuels and provides for the generous benefits promised to all retirees, public and private sector beneficiaries included. And those investing in 401(k)s as well.

So let's look briefly at the current underfunding of public sector pensions and how these promised benefits can best be satisfied. Two things must happen: (1) Enough funds must be contributed and (2) these funds must be invested properly in order for the promised retirement benefits to be fully paid.

Study Shows $1.2 Trillion Gap for Public Pensions says this in part:

"The largest 100 public pension funds have around $1.2 trillion of unfunded liabilities, about $300 billion above the nearly $900 billion they reported themselves, according to a new actuarial study . . . .

The pension systems reported a median funding level of 75.1 percent. The study by the actuarial firm Milliman, which used different ways to value assets and measure liabilities, finds an aggregate level of funding of 67.8 percent. . . . 

The difference between what public pensions across the United States have reported and what Milliman found wasn't significant . . . . a relatively small change in the way the figures are calculated could lead to seemingly outsized results because the funds are so large.

"The numbers really didn't change that much," (the reporter) said. "It really didn't move the needle.". . .

That hot-button issue revolves around how much money public employers - and, by extension, taxpayers - will have to contribute to cover future payouts for member benefits. It is a key issue at a time of dwindling revenues and tighter budgets for states and local governments.

Pension funds get money from the returns on their assets and from members' contributions. States and cities also pay into the funds, but their contributions are discounted based on how much money they think their investments will make over time.

The 100 funds Milliman studied used a median rate of return for their investments of 8 percent. But the recession slashed into the market, dropping actual median returns to just 3.2 percent for the last five years, according to data from Callan Associates.

The difference has prompted critics to claim that the funds are underreporting their unfunded liabilities, or the gap between what they've promised to pay retirees in the future and what they'll actually have on hand to cover the benefits.

Critics have called for public pensions to reduce their assumed rates of return to as little as 5 percent or less, which would cause unfunded liabilities to soar and likely leave taxpayers having to cover the difference. . . .

Other studies have tried to measure the overall size of the problem. . . . Moody's Investors Service said in July that the collective gap would be $2.2 trillion if funds used a 5.5 percent discount rate."

Summing Up 

So what is the real amount of the underfunding? Is it $1.2 trillion or $2.2 trillion?

Well, the answer depends on how the pension funds will be invested and how those investments will then perform over time.

{Of course, first there have to be contributions to invest, and this money comes from both plan participants and plan sponsors.}

The difference between an average annual 5.5% rate of return and an 8.5% rate of return is absolutely huge. And here's how huge it is.

Over a 48 year period, investing at a return of 5.5% will result in 1/4 the total accumulated asset value had that money been earning 8.5% over that timeframe.

Stated another way, over 48 years either the retiree benefits will be 4 times lower or the contributions must be 4 times higher if investments earn 5.5% instead of 8.5%. It's just math, the compounding of interest and the rule of 72 at work. 

Thus, if the rate of return on investment is 5.5% and not 8.5%, and the investing period is a shorter 24 years, the end result will still be 50% fewer benefits or a contribution level that's twice as high to provide the higher benefits.

And the only way to achieve anything close to an average annual rate of 8.5% over an extended period of time is to have a healthy, growing and prosperous U.S. economy led by the private sector. But to do that, Americans have to have confidence in our nation's future and a strong belief that our American way still works.

Which it does and will, given a chance. So here's my take on all this. Buy and hold stocks. Bet on America.

Accordingly, if it were my 'contribution' money and my retirement benefits at risk of not being fulfilled, I would want that retirement money invested in stocks. They have always beaten every other form of investment over any extended period of time

Ownership in America and its private sector companies has never a bad bet. But even if stock ownership somehow may prove to be a bad bet in the future, betting against stocks wouldn't allow me to collect what I would be due anyway down the road. In other words, if the private sector loses, retirees will lose, too. And all others as well. It's the market based system, Stupid!

In other words, the continuation of America's private sector companies' success will assure that our retirement benefits will be paid in full, as long as they are funded and then invested properly.

But in the extremely unlikely event that our market based system fails over time, there won't be enough money in any of our retirement funds to pay those promised benefits anyway.

To repeat, I'm betting on American and its free market system. I always have and I always will.

My strong belief is that you should be betting that way, too, as should all other Americans who are looking to enjoy a safe, secure and comfortable journey into and through old age.

And a good, long and enjoyable working career before that. That's my take.

Thanks. Bob.

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