Pensions at risk by record unfunded liabilities

The United States is beset with many severe financial problems, not the least of which are the looming collapse of the Social Security System, an expanding public debt of $20+ Trillion and the impending collapse of Medicaid and the Affordable Care Act (Obamacare). But perhaps the greater threat to the financial health of the individual American is the enormous unfunded liabilities that continue to be accrued not only by the federal government but also by states, cities and municipalities of varying sizes which are contractually committed to funding the retiree’s pension payments.

In 2013 Moody’s estimated that the shortage of  funds available for federal pensions, civilian, and military employee benefits amounted to $3.5 Trillion. The Director of the Congressional Budget Office, Keith Hall, recently estimated that the state public pension plans are now unfunded by $4.7 Trillion. Total unfunded liabilities now exceed $9.2 Trillion.

The specific causes of municipal insolvencies are myriad, but in every case can be traced to budgetary, fiscal, and/or financial mismanagement. One such cause is that approximately 75% of public retirement funds still operate as defined-benefit plans. Under this arrangement, the amount of the future pension payment is typically negotiated by a labor union which has gained collective bargaining rights. By way of contrast, virtually all corporate pension plans abandoned defined-benefit plans more than 15 years ago in favor of 401-k plans which transfer the pension responsibility from the employer to the individual employee. When a state/city-employer is unable to meet the immediate wage demands, a compromise typically reached assigns the unmet portion of the new increase to future retirement payments. As years go by, these deferred wage obligations grow to unresolvable unfunded liabilities.

This problem is aggravated when unions obtain collective bargaining rights thereby increasing the political leverage that a union negotiator can apply to the municipal negotiator. In many cases the municipal negotiator is beholden to the union which contributed funds for the election of the same municipal negotiator. Under such political pressure the municipal employee usually relents and the future obligation increases. For example, a strike by the teachers union in Chicago, which is a recurrent threat, interrupts the education of  more than 320,000 students each day.

The problem is compounded at the fiscal level when the amount required to be on hand today (the Present Value) to meet these future demands is determined by discounting the future liabilities at a high discount rate. The use of a high rate (7-8%) results in a lower Present Value, seemingly reducing current financial requirements to manageable amounts which reduces the required contributions to the retirement account by both the employee and the employer. In selecting the discount rate, the asset manager also specifies the intended yield on current assets needed to meet the future liabilities. But investment returns in the range of 7-8% are simply no longer attainable by most pension fund managers, many of whose funds are legally restricted to low-interest rate, low-risk government bonds which, when invested at current market rates of 1.7% -2.4%, deliver woefully inadequate cashflow  results. Shortages become the responsibility of the taxpayer.

For example, if California’s current unfunded liability of $956 billion is discounted at 7.5% its apparent Present Value is $323.1 billion.  But if a more realistic discount rate (3.723%) is used, the Present Value of future liabilities rises to $487 billion. Calpers, which manages the California fund, realized a return of 0.61% last year.

Illinois is an example of a state facing near-insurmountable financial problems whose core is the cost of retirement programs. As of June 30, 2016, the state’s total Pension Liability was $208 Billion of which only $78.2 Billion (37.6%) is held as current assets. Chicago mayor Emanuel’s 2015 attempt to transfer funds from union pension accounts to mitigate shortfalls in operating income was  nullified by the Illinois Supreme Court which held that the city’s obligation was a legal debt akin to a mortgage. The Chicago debt was designed to allow union loyalists to retire for half their adult lives on pensions to which they contribute very little. Taxpayers in Illinois contribute more than 3 times the amount state workers contribute to their own retirements. N.J.’s governor Chris Christie was successful in diverting $106 billion from Jersey’s pension payments to balance the 2015 budget. Local unions brought a legal action to the N.J. Supreme court which ruled in favor of the governor. New Jersey temporarily avoided a collapse but Chicago faces bankruptcy.

The impact on Chicago real estate has been intense. In the more affluent areas of the city property taxes in 2016 have risen 13%. In addition, property assessments, which recur every three years, have resulted in valuations which have increased an average of 12.8% and in some instances 20-80%. Taxes on commercial property have risen 10% squeezing landlords operating under leases which limit rent increases. Official Illinois forecasts point to a $1 billion increase in pension contributions from $7.9 billion to $8.9 billion in fiscal 2017. Total unfunded liabilities in Chicago could reach $132.2 billion in 2017.

The unfunded liabilities problem is not confined to a few states. In 2016 not a single state meets its future liability with adequate current assets. The nationwide funding level is only 35% which is 1.0% less than the level reported two years ago. According to a study by the American Legislative Council (ALEC) the unfunded liability is equal to $17,427 per person in the United States. In terms of liability per citizen, however, Alaska ($42,950) and Ohio ($28,538) lead the parade.

Bankruptcy is often mentioned as a solution to the problem in some states, as it was in Detroit, San Bernardino, Vallejo, Stockton, and other municipalities. It is not commonly known that an action to declare bankruptcy by a state or municipality must be brought under Chapter 9, which is a federal proceeding, not a state proceeding. It is also less well known that both private and public bankruptcies were originally considered unconstitutional. When Congress first passed a bankruptcy Act in 1934 the U.S. Supreme court objected citing Article I, Sect. 10, Clause 1 of the Constitution which reads, in part:

“No State shall pass any law impairing the Obligation of Contracts.”

The court recognized pension debt as a contract  and deemed the proposed legislation an impairment of contracts. The court also held that the federal government did not have the right to pass these bankruptcy laws citing the Tenth Amendment which states that powers not explicitly granted to Congress are reserved to the states. It was not until the depression years of 1939 that Franklin Roosevelt succeeded in passing a bankruptcy law by threatening to “pack” the Supreme Court by adding 6 additional liberal judges in his attempt to implement New Deal legislation.

The law is quite uneven over the 51 states as to which states will permit an application for bankruptcy. Most states are very restrictive in approving a municipal bankruptcy since it will often lower the state’s credit rating and raise interest rates on other state obligations. A number of states have no law regarding municipal bankruptcy and therefore provide no legal right to do so.

As this situation ripens, millions of future retirees are very likely to receive insufficient social security payments to supplement a reasonably comfortable retirement (although social security was never intended to do this). Middle and lower income groups are most severely affected as the federal government continues to artificially suppress interest rates which unrewards savings; almost half the U.S. population has little or no retirement savings.

Meanwhile, federal and public government employees continue to accrue pensions and benefits at a rate in excess of government’s ability to raise the necessary cash. As a result, the prospective retiree can look forward to working beyond age 67, to smaller payment retirement checks and higher taxes on cash received. These reductions and cutbacks portend a substantial decline in the standard of living for the average non-government worker as prices increase and the purchasing power of the dollar decreases.

What needs to be considered is enactment of right-to-work laws and the removal of the ability for public unions to collectively bargain for benefits. The results in Wisconsin achieved by Governor Scott Walker are both dramatic and instructional.


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