Software Nerd

Friday, October 10, 2008

Public Retirement Deficit -- another $700 billion?

Once the housing-related crisis is history, what other un-budgeted government payouts loom ahead? The big ones are Social Security and Medicare; but people know about those. One that is not as much on the radar is the shortfall in state government pension funds.

According to a PEW study "Promises with a Price" , "states’ retiree ... benefits ... due over the next [three] decades that can be conservatively estimated at $2.73 trillion. That includes about $2.35 trillion for a wide range of employee pensions, including those for teachers, and an additional $381 billion for retiree health care and other non-pension benefits for state employees only, excluding those for teachers and a handful of other groups. ... ... To their credit, states have socked away enough to cover about 85 percent of the pension bill. But there is very little put aside for non-pension benefits. All told, states face about $731 billion in unfunded bills coming due. "

Assumed Rate of Return: One major assumption is: how much will pension funds earn on their investments. Today, the plans assume a return of a little over 8% p.a. This is far from conservative for a pension-fund. As Berkshire's Charlie Munger's remarked (Wesco shareholder's meeting, 2008) pension funds rather take on more risk, than admit they cannot make 8% over the long term, which would mean an adjustment (requirement for new "top-up" funding) today.

A news-story about San Deigo shows some of the short-sightedness that goes on. The city was assuming an 8% return. Obviously this means that some years will be higher and others will be lower. The wise folk who run the city decided that in any year that they make more than the average 8%, they would use the "surplus" to re-calculate a more generous retirement package!
Similarly, during the late 1990's, when the stock-market boomed, some states skipped their funding, declaring a pension-funding "holiday".

If the recession we're currently in, and the government's shenanigans that promise big structural impediments to the markets, leads to a 6%-7% stock-market growth over the next decade or two (some would say I'm being optimistic), pension fund deficits will be significantly higher than $360 billion.

Assumed COLA: It appears that public pensions do get cost-of-living adjustments (COLA). Fortunately (for the government budgets) these seem to be decided by ad-hoc union bargaining, rather than by a strict formula linked to CPI. Nevertheless, if inflation ratchets up in the 2010's, we can expect calls for more COLA, and a higher bill.

Summary: $360 billion pension shortfall, and $370 billion) retiree health-care shortfall. If the stock-markets grows more slowly, the pension shortfall could be higher. If inflation grows faster, both the pension and healthcare shortfalls could be higher. A trillion might be a nice, round, conservative figure.

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