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June 2012
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IN DISTRESS Study finds public pension collapses not mere outliers

It's no longer news that many a public pension plan is in deep trouble these days.

The city of Detroit is in bankruptcy proceedings, in no small part due to its runaway pension obligations. The latest plan for the city to exit bankruptcy entails cuts of 26 to 34 percent to monthly pension checks of retirees in Detroit's General Retirement System; this despite proposed infusions of $350 million from the state and $466 million from philanthropic organizations to help the city meet obligations going forward.

Then there's Chicago. It has a $9.4 billion hole in its pension fund, which will go broke in a little more than a decade absent painful changes.

And of course there's the state of Illinois, the poster child for pension crises, with its worst-in-the-nation $97 billion pension gap as of 2013.

But those are outliers, right? Sure, states and cities everywhere have made generous pension promises to public employees, but most of them are good for it. Aren't they?

Apparently not. An article last week in USA Today cited an analysis by "influential and well-regarded hedge fund Bridgewater Associates" that finds public pensions are likely to achieve annual returns of 4 percent or worse in years ahead, well below historical trends. If so, the analysis says 85 percent of all public pension funds will go bankrupt over the next three decades.

Bridgewater reached its conclusions after conducting a Federal Reserve-style "stress test" (such as the ones major banks now regularly undergo) on the nation's public pension programs. The firm found that public pensions have $3 trillion in assets available to invest to cover $10 trillion in retirement obligations over the next several decades. The firm calculates an investment return of 9 percent a year would be required to meet those obligations.

Many pension funds assume annual returns of 7 to 8 percent in claiming their programs are fully funded. But the Bridgewater study finds that even if those levels were achieved (and they won't be) public pensions are looking at a collective 20 percent shortfall in available cash in the long term. At the more probable rate of 4 percent returns, disaster looms.

The projections reflect how the world has changed in the wake of the Great Recession. In years past, when the prime rate was 5 or 6 percent and the return on 30-year U.S. Treasuries was in that same ballpark, the assumed returns used by pension actuaries were more realistic.

But 30-year Treasuries today pay in the 3.5 percent range and the Federal Reserve doesn't seem inclined to change its low-interest rate posture anytime soon because of painfully slow economic growth and a workforce participation rate that is at its lowest in more than 30 years.

For years, politicians and employee-union leaders in governments large and small bought political favor by agreeing to rich pension plans that were certain to eventually collapse. In doing so, neither side served its constituents.

Those representing government set their communities or states up for the Detroit/Chicago experience. Those representing workers set their constituents up for broken promises such as Detroit pensioners now face in mid-retirement.

Some in these negotiating roles probably acted out of naivety. Some surely knew what they were doing, leaving it for others to face the anger and take the harsh steps required to head off total collapse. Unfortunately, it is beginning to look like Detroit and Chicago are not outliers. Public pensioners everywhere need to prepare for the likelihood promises made during their working years are going to come up short.

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