#pensionblackhole

Illinois Police Pension can’t protect or serve – it is going bust

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Sadly the Illinois Police Pension is rapidly approaching the point of being unable to service its pension members and a taxpayer bailout looks unlikely given the State of Illinois’ mulling bankruptcy. Local Government Information Services (LGIS) writes, “At the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following year…Fund assets will fall from $3.2 billion at the end of 2015 to $1.4 billion at the end of 2018, $751 million at the end of 2019, and $143 million at the end of 2020, according to LGIS…LGIS analyzed 12 years of the fund’s mandated financial filings with the Illinois Department of Insurance (DOI), which regulates public pension funds. It found that– without taxpayer subsidies and the ability to use active employee contributions to pay current retirees, a practice that is illegal in the private sector– the fund would have already run completely dry, in 2015…The Chicago police pension fund held $3.2 billion in assets in 2003. It shelled out $3.8 billion more in benefits to retired police officers than it generated in investment returns between 2003 and 2015…Over that span, the fund paid out $6.9 billion and earned $3.0 billion, paying an additional $134 million in fees to investment managers.”

The public pension black hole in America is an alarming issue.  In the piece, “The Public Pension Black Hole” it was plain to see the problems of unfunded state pensions is rife across America. Take California- “The US Federal Reserve (Fed) reported in 2013 that the State of California had an official unfunded pension liability status equivalent to 43% of state revenue. However, if marked-to- market with realistic discount rates we estimate that it is equivalent to 300% of state revenue or 7x greater. Going back to 2000, California had an unfunded liability less than 11% of tax collections. As a percent of GDP it has grown from 2% to 9.7% based on official figures. If our estimate is correct, the mark-to market reality is that California’s unfunded state pension (i.e. for public servants only) is around 18% of state GDP!”

The problem for Illinois is that a taxpayer funded bailout is all but impossible. The State of Illinois ranked worst in the Fed study on unfunded liabilities.  The unfunded pension liability is around 24% of state GDP. In 2000 the unfunded gap to state revenue was 30% and in 2013 was 124% in 2013. Chicago City Wire adds that the police fund isn’t the only one in trouble.

“Chicago’s Teachers Union Pension Fund is $10.1 billion in debt. Its two municipal worker funds owe $11.2 billion and its fire department fund owes $3.5 billion…All will require taxpayer bailouts if they are going to pay retirees going into the next decade…Put in perspective, the City of Chicago’s property tax levy was $1.36 billion in 2017…Paying for retirees “as we go,” which will prove the only option once funds run dry, will require almost quadrupling city property tax bills…Last year, it would have required more than $4 billion in revenue– including $1 billion for City of Chicago workers, $1.5 billion for teachers, and $1.5 billion for retired police officers and fire fighters.”

This problem is going to get catastrophically worse with the state of bloated asset markets with puny returns. Looking at how it has been handled in the past Detroit, Michigan gives some flavor. It declared bankruptcy around this time three years ago. Its pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

In order for states and local municipalities to overcome such gaps, they must reorganise the terms. It could be a simple task of telling retiree John Smith that his $75,000 annuity promised decades ago is now $25,000 as the alternative could be even worse if the terms are not accepted. Think of all the consumption knock on effects of this. I doubt many Americans will accept that hands down, leading to class actions and even more turmoil.

 

Pension Sinkhole

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The pension problem that many in the US face is no laughing matter. ‘Tis but a scratch is how many (especially state run) pension funds continue to view their predicament outwardly. Internally they must be panicking. Actuarial accounting is a wonderful thing. Tweak a few assumptions and immediately wash away a deep deficit. To put this in perspective the California Public Employee Retirement System (CalPERS) lost around 2% of its funds in 2015/16. The fund assumes an aggressive 7.5% return. Dr. Joe Nation of Stanford Institute for Economic Policy Research thinks unfunded liabilities have surged to $150bn from $93bn in the last two years. Furthermore suggesting the use of a more realistic 4% rate of return. CalPERS has an unfunded liability of $412bn (or the equivalent of 3 years’ worth of state revenue). California collects $138bn in taxes annually in a $2.3 trillion economy (around the size of Italy). With over-inflated asset markets and increasingly negative returns on highly rated paper, the growth in unfunded liabilities is even more concerning as any market correction (likely to be severe given such blatant manipulation to date). If the correction is huge it will push the unfunded portion to even more dizzying levels.

According to a Bureau of Labor Statistics report from 2015, the average household income of someone older than age 75 is $34,097 and their average expenses are around $34,382. Despite such austerity, a pension collapse would literally kill off the ability to live a bare bones existence.

Years of poor investments have stuffed South Carolina’s government pension plans with a massive funding gap. The plans serve about 550,000 (11%) of residents, and the shortfall of $24.1 billion is more than 3x Palmetto State’s annual budget.

Rewind to 2008. The municipality of Vallejo, California filed for bankruptcy. It wasn’t just the evil bankers that caused financial markets to collapse resulting in tax revenues shrivelling. Sadly, the city of Vallejo was living high on the hog. Bloated pensions and fat cat salaries for public servants ruled by stubborn unions created a scenario where it could not bail water fast enough when the crash hit.

The police captain was paid over US$300,000 while his lieutenants were on c.US$250,000. The average fire fighter took home US$170,000. The police and firefighters pay and conditions sucked up three-quarters of the budget much more than the 55-60% of most municipalities. That $80mn budget suddenly faced a $17mn black hole.

The city was forced to fire 40% of its 260 police officers and told its residents to be judicious with calling 911. Crime rates soared above the state average.

Vallejo did not sort its pension obligations to CalPERS during its bankruptcy negotiations which ended up becoming its largest budget hole by a considerable margin. Even in 2011 when the city came out of bankruptcy the pension time bomb ticked away. Moreover, the declaration of bankruptcy prevented access to bond financing making budget gap filling even more complicated.

Fast forward to 2016, the anaemic (and slowing) economic growth around the world is putting stress on pension funds ability to payout retirees and fund future pensions. Pension funds set “return targets” which actuaries calculate to ensure the fund stays solvent. However, pension funds need to be diversified with a mixture of cash, bonds and equities. With equities reaching more outlandish valuations and bonds moving further into negative yield territory (capital appreciating at least) pension fund returns are undershooting. When pension funds undershoot then the unfunded liabilities keep growing. As more baby boomers retire the more outflows are putting more pressure on the unfunded portions.

San Bernardino, California also filed for bankruptcy after GFC carrying $140mn in unfunded pension liabilities including $50mn in debt it had to raise to fill the pension hole. Yes! It was borrowing money to plug a pension hole. Sort of like buying groceries on the credit card you can’t pay off.

Take Detroit, Michigan. It declared bankruptcy around this time three years ago. Its pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

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Scroll forward to 2013 and this is how it looks. 2017 would look even more terrible.

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Do people then rely on Social Security? Well, according to the 2016 Social Security Trustees report it shows at the current rate the Social Security’s combined retirement and disability trust funds will be empty by 2034. The trustees estimate that the 75-year shortfall is $11.4 trillion in NPV terms. Good luck filling that.

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