Tuesday, July 24, 2012

When Pension Myths Confront Reality?

Jilian Mincer of Reuters reports, Public pension funds to face calls to set realistic targets:

Public pension funds are expected to report poor annual returns in the coming weeks, results that are likely to increase calls for more realistic retirement promises for teachers, police officers and other public workers.

At least three of the nation's largest U.S. public pension funds have already announced returns of between 1 percent and 1.8 percent, far below the 8 percent that large funds have typically targeted.

The fund's targets have been "unrealistic," said Michael Lewitt, a portfolio manager at Cumberland Advisors in Sarasota, Florida. "They've been fooling themselves because there is no realistic case they can make that."

The euro zone debt crisis, record low interest rates and weak growth across the globe made the last year a meager one for financial investments in general. U.S. public pension funds were no exception.

Low returns will further aggravate funding shortfalls for hundreds of pension plans, adding to pressure on cities, counties and states that are already facing lower tax revenue and rising costs.

The vast majority of states have cut pension benefits or increased contributions from workers, or are trying to.

"Failing to understand the scope of the pension crisis sets taxpayers up for a bigger catastrophe in the future," said Bob Williams, president of free-market think-tank State Budget Solutions, in Washington.

"Without government action, states, counties, cities and towns all over America will go bankrupt," he said.

In recent weeks, two cities in California sought protection from creditors. A third, San Bernardino, will follow suit soon and others such as Compton are considering the option.

In other states, from Michigan to Pennsylvania, cities such as Detroit and Scranton are struggling to make ends meet.

Last week the $233 billion California Public Employees Retirement System, the biggest U.S. public pension fund, reported a 1 percent return on its investments for the year ended June 30, way below CalPERS' 7.5 percent target.

That assumed rate of return was cut earlier this year from 7.75 percent, a reduction some critics said was too timid.

Similarly, the $150.6 billion California Teachers pension fund, or CalSTRS, earned only 1.8 percent. Various New York City pension funds reported an annual return of 1.7 percent.

A better performance was reported by the $150.3 billion New York State pension fund, which closed its fiscal year at the end of March with an almost 6 percent return, helped by an earlier end to its financial year, sparing it recent market losses.

Florida's state workers pension fund, which has an estimated net asset value of $123.7 billion, is due to report in the next two weeks. Hundreds of other, smaller funds are also scheduled to announce results for the 2012 fiscal year soon.

"Fitch expects numerous systems to report similarly disappointing returns. This is likely to further pressure pension systems' funded ratios and lead to higher annual contributions for state and local governments," said the rating agency in a statement last week.


Major public pensions typically assume an average return of about 8 percent, but the median annual return in 2011 for large pension funds was roughly half that amount, 4.4 percent, according to data provided to Reuters by Callan Associates.

Median returns were only 3.2 percent for the last five years and 6 percent for the last 10.

Before the 2007-09 recession, market performance was often above the 8 percent assumptions. Average returns for the last 20 or 25 years as a whole still reach that level.

But with losses in 2008 and 2009 and uneven returns since then, analysts say pension funds should adjust to what seems to be a new reality.

Weak returns for fiscal 2012 are likely to push averages even lower, widening the gap with long-term expected rates used for life-long estimates.

Pension funds use the expected return targets to discount their future liabilities for employees whose future benefits are pre-defined. While lower projected returns would be more realistic, states and local governments have been reluctant to change because it would require already financially strained states and municipalities to increase contributions or decrease benefits.


The funding status of public pensions has dramatically slipped over the last decade.

Barely more than half were fully funded in 2010. At the end of that year, the gap between public sector assets and retirement obligations had grown to $766 billion, according to a report by the Pew Center on the States.

Ratings agency Moody's Investors Service calculated this month that if it used a 5.5 percent discount rate, a rate closer to the way private corporations value their pensions, it "would nearly triple fiscal 2010 reported actuarial accrued liability" for the 50 states and rated local governments to $2.2 trillion.

Other estimates put the shortfall even higher. State Budget Solutions estimated it in a recent study at $4.6 trillion as of 2011.

Some pension funds, such as CalPERS, have begun to lower their assumptions. New York's state pension fund, one of the best funded across the nation, lowered to 7.5 percent its projected rate of return in 2010.

Earlier this month, Baltimore County's employee pension system lowered its projections to 7.25 percent from 7.875 percent.

"The fact that (pension funds) are moving means they're concerned," says Alicia Munnell, director of the Center for Retirement Research at Boston College.

She thinks that for planning purposes 6 percent would be more realistic.

"But states and localities have not really recovered from the Great Recession. In this environment everything needs to go slowly," Munnell said.

It's about time US public pensions wake up and stop perpetuating the myth of 8%! A while back I wrote a comment, warning what if 8% is really 0%. The ugly truth is if US pensions were using the same discount rate large Canadian public pensions use, the majority of them would be insolvent.

Another myth I wanted to bring to your attention is one that the American Academy of Actuaries discusses in a recent paper, The 80% Pension Funding Standard Myth (h/t Benefits Link News). Will leave it up to you to read this short paper but it concludes:

A funded ratio of 80% should not be used as a criterion for identifying a plan as being either in good financial health or poor financial health. No single level of funding should be identified as a defining line between a “healthy” and an “unhealthy” pension plan. All plans should have the objective of accumulating assets equal to 100% of a relevant pension obligation, unless reasons for a different target have been clearly identified and the consequences of that target are well understood.
It's clear from the myth of 8% assumed rate of return to the 80% pension funding standard myth, US public pensions need to get a grip on reality.

Go back to read my weekend comment on the banking mafia and listen to the comments by Paul Craig Roberts on why banksters are intent to keep interests rates artificially low for as long as possible, making billions in profits manipulating rates lower to make money on interest rate swaps and trading risk assets in this volatile wolf market.

Leo de Bever is right, there are storm clouds ahead when this bond bubble blows up, but after reading the article Roberts co-authored with Nomi Prins on the real LIBOR scandal, I'm convinced banksters have a stranglehold on just how high interest rates will go.

And unlike Roberts, I don't see any run on the US dollar. Quite the opposite, I see the greenback strengthening. I'm bullish on America and realize every time a financial crisis hits, the flight to safety benefits the greenback.

Below, leave you with a couple of Bloomberg interviews. First, Gary Shilling talks about the impact on pension plans of the Federal Reserve's monetary policy. He explains why the move to alternative investments in an era of deleveraging is exposing pensions to significant downside risk.

In the second interview, Bloomberg's Cristina Alesci talks with KKR head of asset management Bill Sonnenborn on his company's move into the hedge fund business and their purchase of fund of funds Prisma.

Not surprisingly, Sonnenhorn is talking up their business but I warn you, alternatives are no panacea and most investors have been badly burned by hedge funds. The myth of outperforming hedge funds and other alternatives will be exposed as the era of deleveraging persists.

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