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Posted by Debi G Hill, CPA

Public Pension Crisis in the U.S: What’s really going on?

Public Pension Crisis in the U.S: What’s really going on?

The U.S is facing a big problem when it comes to public pensions across the country. The outlook for investment returns is worsening while the gap between their assets and liabilities is growing.

Chief Investment Officer Ben Meng told the board of the California Public Employees’ Retirement System last week that for the next 10 years, expected returns will be 6.1%, not 7%. The investing return target of Calpers, the country’s largest pension at about $366 billion, lowered to 7% in late 2016.

Let’s take a look at what has happened and what actions are being taken related to pensions:

Widening of Funding Gap

The average U.S plan had only 72% of its future long-term obligations in 2018 compared to 2011 when it was more than 100%. This means even a record bull stock market hasn’t been enough of a boost. The growing imbalance is the result of the recessions, insufficient government contributions and generous benefit guarantees as a state by the Centre for Retirement Research at Boston College. Investing decisions often hurt as well.

Associate Director, Jean-Pierre Aubry said the really bad plans largely came from equities after the financial crisis.

Why Simple is Better

Funds that poured into so-called alternative investment vehicles like hedge funds or private equity have been outperformed by pensions that bet aggressively on stocks especially companies from the U.S. President of Wilshire Consulting said that even though diversification is the right strategy, it sometimes makes you look dumb.

Philippi Nelson, asset-allocation director at pension advisory firm NEPC said loading up on stocks may not pay off the same in the coming years. He added that it both seem really unlikely for an equal amount of Fed support and profit margins increasing by another 50% over the next ten years.

Alternatives Are in Vogue

Private equity allocations were increased by public pensions in 2018 to 10% on average from 5.6% in 2008. This trend is likely to continue in the hunt for yield. Mega plans are hiring additional staff to manage private equity internally and other alternative assets which in the future is expected to beat stocks with. Alternatives and plans are being invested by the Texas Teachers’ Retirement System with 40% of its portfolio and in five years, plans to double its staff.

Senior Managing Director of asset allocation at Texas Teachers, Mohan Balachandran said their pension liability duration is 20-plus years and that could invest for the long-term in some of these vehicles where the money is locked up for seven to 12 years.

Allocation of Assets

Since 2014, return assumptions have been cut by public pensions for about 85% of 129 U.S public pensions. This recently includes the Pennsylvania State Employer’s Retirement System. After the last recession, pension started scaling back. Keith Brainard, the research director at the National Association of State Retirement Administrators said the average target will probably go low.

He also added that more ammunition is provided to justify lower investment returns if each month and each quarter that goes by has permanent low inflation and interest rates.

The Answers Won’t Always Be Easy

Easier targets aren’t always politically palatable even though they are prudent from a risk perspective. When investment projections go through a dollar drop, it also means a dollar is taken from the pocket of taxpayers.

The plan of the Kentucky Retirement System for 123,000 employers in non-emergency jobs comes with $2 billion in assets for $15.6 billion in liabilities. As for allocation to equities, it has only 35% and because it can’t spare cash on volatile or locked-up holdings, it has stopped new investments in private equity. The burden with regards to pensions is resulting in government service cuts, freezing of pay, and a falling headcount just consuming itself.

Director David Eager said this is called the death spiral and no one will be able to earn their way out of this.

It’s unreasonable for our families, friends, neighbors, and the middle-class bedrock of our great nation if we don’t do anything to address this crisis. To fix the multi-employer pension plan system and everything that’s involved with pension plans, it’s important that the public sector and private sector work together as soon as possible. Americans don’t have a lot of time to wait for this to happen.

Debi G Hill, CPA
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