The state pension funds were fully funded just a few years ago. One could make the argument that we are “broke” because of all the BS artists on Wall Street. It’s the collapse of the RE/credit/stock market bubbles that have put the pension plans in such a precarious position.
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The state pension funds most certainly were NOT fully funded a few years ago, despite all protestations and accounting “evidence” to the contrary. This claim is a cannard. The “fully-funded” status was a mirage built on faulty assumptions.
The degree to which a pension plan is over- or under-funded depends upon a set of assumptions. The primary assumptions are (1) the future rate of return on the plan’s assets, and (2) the future growth in the plan’s liabilities (that is, benefits to be paid out to the pensioners).
So, we’re dealing with assumptions… and we all know what happens when we assume… but I digress.
The problem with most pension plans – SD’s included – is that over the last 20 years+, the assumptions on both sides of the balance sheet have been too aggressive. The return on plan assets has generally been assumed to be 8% or so. So, let’s look at that number. If 60% of your assets are in bonds and 40% are in stocks, and bonds return an average of 6% over the life of the plan, then what’s the imputed return on the stock portion over the life of the plan? A little algebra reveals it’s 11%. This is the assumed equity return number that most pension plans have been using since the late-90s because that was the recent historical experience. The problem was that nobody sat back and said, “Given a 2% dividend yield, long-term EPS growth of 5%, and high valuations, what SHOULD the expected return be going forward?” [Less than 7% would have been a decent answer, but that would have been an inconvenient truth.] So, the assumptions on the asset side have been out of whack for a long time. Buffett and others have been railing about the absurdity of the return assumptions in pension plans for years.
On the liability side, the problem is that health care costs have been increasing at well above the assumed rate for years.
So, we have a double whammy: unrealistically high return assumptions and unrealistically low benefit-increase assumptions. And here we are with a massive deficit. It’s been there all the time, but it’s been obscured by accounting conventions and faulty assumptions. Kind of like our financial system. But, again, I digress.
Wall Street has a lot to answer for. But, it ain’t the pension debacle we are currently facing. Nope, that’s largely on the folks that run the plans (and make the silly assumptions) and the accountants who sign off on such silliness.
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This article covers some details regarding the post above. It’s a disturbing read.
