Defined Benefit Pension Plans are, in many cases, a ponzi scheme. Current assets are used to pay current claims in full despite insufficient funding to pay future liabilities… classic Ponzi. But unlike wall street and corporate ponzi schemes no one goes to jail here because the establishment is complicit. Everyone from government officials to union bosses are incentivized to maintain the status quo…public employees get to sleep better at night thinking they have a “retirement plan,” public legislators get to be re-elected by union membership while pretending their states are solvent and union bosses get to keep their jobs while hiding the truth from employees.
So what allows this ponzi to persist? It all comes down to one simple assumption: Discount Rates. You see, if you simply discount future liabilities at a high enough discount rate then you can make any massively underfunded pension ponzi look like a stable, healthy retirement gold mine.
In fact, just over a year ago we took a look at what would happen if we calculated the true underfunded level of America’s public pensions at more reasonable discount rates. The result showed that the media’s highly referenced underfunding of $2 trillion soared to something closer to $5-$8 trillion when more reasonable discount rates were employed.
We decided to take a look at what would happen if all federal, state and local pension plans decided to heed the advice of Mr. Gross. As one might suspect, the results are not pleasant. We conservatively assume that public pensions are currently $2.0 trillion underfunded ($4.5 trillion of assets for $6.5 trillion of liabilities) even though we’ve seen estimates that suggest $3.5 trillion or more might be more appropriate. We then adjusted the return on asset assumption down from the 7.5% used by most pensions to the 4.0% suggested by Mr. Gross and found that true public pension underfunding could be closer to $5.5 trillion, or over 2.5x more than current estimates. Others have suggested that returns should be closer to risk-free rates which would imply an even more draconian $8.4 trillion underfunding.
Now, the state of Minnesota has gracefully stepped forward to beautifully illustrate our point. Upon making a few minor “tweaks” to their various funds’ discount rates, the state found that their aggregate pension underfunding more than tripled from roughly $16 billion to over $50 billion. Here’s more from Bloomberg:
Minnesota’s debt to its workers’ retirement system has soared by $33.4 billion, or $6,000 for every resident, courtesy of accounting rules.
The jump caused the finances of Minnesota’s pensions to erode more than any other state’s last year as accounting standards seek to prevent governments from using overly optimistic assumptions to minimize what they owe public employees decades from now. Because of changes in actuarial math, Minnesota in 2016 reported having just 53 percent of what it needed to cover promised benefits, down from 80 percent a year earlier, transforming it from one of the best funded state systems to the seventh worst, according to data compiled by Bloomberg.
The Minnesota’s teachers’ pension fund, which had $19.4 billion in assets as of June 30, 2016, is expected to go broke in 2052. As a result of the latest rules the pension has started using a rate of 4.7 percent to discount its liabilities, down from the 8 percent used previously. As a result, its liabilities increased by $16.7 billion.
But other factors also helped boost Minnesota’s liabilities: Eight of Minnesota’s nine pensions reduced their assumed rate of return on their investments to 7.5 percent from 7.9 percent, while three began factoring in longer life expectancy.
All of which resulted in this:
Of course, Minnesota’s underfunding didn’t just magically “soar by $33.4 billion” as Bloomberg puts it…in reality, the state’s pensions were always underfunded by ~$50 billion…the only difference is that that some pension administrators finally decided to stop lying to their retirees and report reality.
All of which rendered this Bloomberg map from just two months ago showing an 80% funding ratio for Minnesota completely obsolete…
…Sorry, Minnesota teachers but you’re almost as screwed as your counterparts in Illinois…you just didn’t know it until your bosses finally decided to stop lying to you.