The Public Pension Ticking Time Bomb

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An unpleasant truth may be coming to light for municipal governments of many of America’s largest cities, as fiscal managers realize that their Defined Benefit Pension Plans (DBPPs) are essentially large Ponzi schemes that have been allowed to fool workers into believing their retirement benefits are fully funded.

But in many cases, these plans are on the edge of insolvency or will have other tragic outcomes unless drastic changes are made. However, unlike other Ponzi schemes, no one will end up going to jail because all of the official parties involved are complicit in the negligence.

Essentially, the problem is that the plans have built in overly optimistic expectations of investment returns in order to provide the “defined benefits” that retirees are expecting. For instance, the largest public pension plan in the country, California’s Public Employees’ Retirement System (CalPERS), like many pension plans, has fund managers that have been estimating their investment returns at 7 to 8 percent annually. But for the most recent fiscal year, CalPERS reported gains of only 1 percent.

The problem has come to light especially harshly in Dallas, Texas where recently, the city government announced that workers in its police and fire departments would not be allowed to make lump-sum pension withdrawals due to their plan being underfunded.

Alarm bells are starting to sound across the country. James Quintero, the Director of the Texas Public Policy Foundation stated that municipal governments’ plans in many cases rely on “fuzzy math to make them work, or at least give them the appearance of working.”

Recently, Quintero gave an interview to the conservative BattleSwarm blog, in which he declared, “There are other ticking time-bombs, like the Dallas Police & Fire Pension (DPFP) out there, getting ready to explode. It’s not just Dallas’ pension plan that’s taken on excessive risk to chase high yield in a low-yield environment.”

He went on to say, “ Setting aside the issue of risk for a moment, the DPFP, like most other public retirement systems around the state, suffers from a fundamental design flaw. That is, it’s based on the Defined Benefit (DB) system, which guarantees retirees a lifetime of monthly income irrespective of whether the pension fund has the money to make good on its promises or not. This kind of system is akin to an entitlement program, warts and all, and is very much at the heart of pension crises brewing in Texas and across the country.”

One of the biggest problems with defined benefit (DB) plans is that they rely on a lot of fuzzy math to make them work, or at least give them the appearance of working. Take the issue of investment returns, for example. Many systems assume an overly optimistic rate of return when estimating a fund’s future earnings. Baking in these rosy projections is, among other things, a way to understate a plan’s pension debt.

The common element in most, if not all, of these systemic failures is the defined benefit pension plan. Because of the political element as well as the inclusion of inaccurate investment assumptions in the DB model, these plans are almost destined to fail, threatening the taxpayers who support it and the retirees who rely on it. And sadly, that’s what we’re witnessing now across the nation.

The problem for taxpayers is that when a city like Dallas runs out of money to pay the police and fire benefits, it can’t just walk away from its obligations without doing something like declaring bankruptcy as Detroit did spectacularly in 2013. More likely, the scenario that will play out is that taxes will have to be increased in a massive way to continue to pay out the benefits and lump-sum withdrawals that are made.

Quintero confirmed this, saying, “Article XVI, Section 66 of the Texas Constitution plainly states that non-statewide retirement systems, like DPFP, and political subdivisions, like the city of Dallas, ‘are jointly responsible for ensuring that benefits under this section are not reduced or otherwise impaired’ for vested employees.” When he was asked if other cities in Texas were as badly off as Dallas, Quintero replied, “If you’re a taxpayer or property owner in one of Texas’ major cities, I’d be concerned.”

Despite one of the largest bull market runs in modern history either continuing or tapering depending on who you talk to, many of Texas’ largest public pension funds, such as those for Austin, El Paso, Fort Worth, Galveston, Houston and San Antonio public workers, are underfunded by ratios of less than 80 percent — indicators that these plans are financially unsound. Dallas’ DPFP is one of the worst cases, with a ratio of just over 50 percent funding, but Houston and Fort Worth aren’t far behind.

And what’s happening in Texas is sure to also be occurring in other states around the country.

In Illinois, the state’s largest public pension plan, the Illinois Teachers’ Retirement System (TRS), said that it’s only 41.5 percent funded. The TRS’s Richard Ingram contends that other plans should be concerned. “Anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality,” argues Ingram.

Writer Walter Russell Mead at The American Interest quarterly review calls this scandal “a slow-motion train wreck” and notes that the American Academy of Actuaries and the Society of Actuaries have abruptly disbanded a Joint Pension Task Force due to objections to a task force report on the issue.

A member of the task force, Edward Bartholomew, said bluntly, “This paper [is] being censored by the AAA and the SOA… They didn’t want it to get out.” Other members of the task force concur, claiming the groups are attempting to suppress publication of the report, hinting at legal consequences if it’s made public. Apparently, the fear is that if the information seeps out, many workers will rush to try and make lump-sum withdrawals, leading to catastrophic underfunding of many pension plans.

The American Interest’s Mead writes, “Union officials and state legislators (in both political parties) seem to believe that it makes more sense to allow public pension funds to play ‘let’s pretend’ with public money.” Current estimates of how underfunded public pension plans are nationally range from $2 trillion to $8.4 trillion, or as much as $23,000 for every American man, woman and child.

Mead believes the solution is to change the plans from “Defined Benefit” plans to “Defined Contribution” plans, which would allow workers to change jobs without losing the full value of their pensions. According to Mead, “The current system creates a jobs-for-life mentality in public employment because workers need to stay in their positions for decades to collect the full value of their pensions. Somebody who was a good teacher at 30 but wants to leave and should leave at 40 is currently trapped. Also, one of the reasons the unions fight quality evaluations so fiercely is that the loss of job and pension is so much more draconian than simply losing a job.”

As this issue begins to become more and more visible, it would be wise for municipalities and taxpayers alike to confront it head-on rather than “kicking the can down the road” for another decade. Any workers enrolled in such a plan currently would be wise to inquire about their plan’s financial status and to evaluate the economic conditions of the city in which they labor.

Regards,

Ethan Warrick
Editor
Wealth Authority