We’ve often discussed problems facing state pension systems, but now we’re seeing the makings of a crisis forming over unfunded liabilities and state pension systems.
This time on the Financial Sense Lifetime Income Series, Jim Puplava discusses what he sees as a coming tsunami of pension problems for retirees.
Perfect Storm Brewing
This analogy of a perfect storm is appropriate, Puplava noted, because of the scale of the problem facing federal and state agencies when it comes to meeting pension obligations. The fact is, there are a number of forces all converging at the same time that will hit and cause widespread problems for pensioners.
It boils down to unfunded pension liabilities both at the state and the municipal level, Puplava noted. Politicians have made unrealistic promises to public workers during good times to build political clout, he added, but during times of low investment returns, these promises have become unrealistic and untenable.
The other aspect of the coming storm is rising Medicaid costs, which are squeezing state budgets, Puplava stated.
We’re covering this crisis in part because of a new study published by the Pew Foundation that supports these conclusions.
“If you were a state or a municipal worker in a troubled state, you should be made aware of it,” Puplava said. “In the next decade, you're going to see many of these states begin to reduce benefits to retirees. It's already happening right now. They're going to change the guarantees offered and they're going to reduce pension payouts.”
We can trace the origin of the problem back to 1965 when President Lyndon Johnson pushed through Medicare and Medicaid, Puplava said. Medicaid is paid for by the states, covering low-income families, people of all ages with disabilities, and people who need long-term care. The level of coverage also expanded under Obamacare, he added.
The problem is, growth of Medicaid costs is outpacing tax revenues year after year at the state level. In 2016, state and local governments collected $136 billion more in taxes than they did in 2008, Puplava noted. Over two-thirds of those dollars went to fund pensions and Medicaid.
It’s important to remember that for states, Medicaid payments are mandatory, as are pension payments, meaning that these have to be included in the budget and can’t be reduced.
Federal actuaries predict Medicaid's annual cost, which was $600 billion in 2017, will rise to $1 trillion by 2026, Puplava stated. States pay about 40 percent of the cost of Medicaid, and as such, they’re slated to face serious budgetary issues in the near future.
“The higher and faster Medicaid payments rise, the less money is left in the state budget for essential services,” Puplava said. “Many states have had to cut everything from fire protection to police coverage. … To save more, many of the states are sending less aid to the cities, which in turn are increasing fees, fines, and taxes. … It's not only going to affect the state's first and municipal workers but eventually, it will be coming on the federal side as well.”
Many states and those administering public pensions, such as CalPERS in California, include unrealistic expectations of returns of 7.5 percent annually to calculate their funding, Puplava noted.
The Pew Foundation study found that state pensions only earned 1 percent on their assets in 2016, versus their assumptions of 7.5 percent. This disparity added $146 billion to unfunded liabilities for that year. The Pew study also found that state pensions right now are sitting on roughly about $2.6 trillion in assets versus total pension liabilities of $4 trillion.
So even a small change in the rate of return can impact pension liabilities dramatically. On top of that, Puplava noted, we're more likely in the next 2 years to face a recession and a bear market.
States aren’t contributing enough to sufficiently fund the cost of new benefits, because obviously the amount of money the state has to put into the plan comes out of the budget.
When Moody’s examined pensions’ operating cash flow, which measures inflows and outflows of a pension fund, the results were staggering, Puplava noted. Most public pension plans have negative ratios, he added, meaning they are paying out more than they are taking in from investment returns and contributions.
“We've been in this low-interest rate environment since roughly about 2008, and everybody's scrambling trying to earn a rate of return,” Puplava said. “They're taking on a lot of risks to do that. … If you're a public employee, you should really make yourself aware of your state's fiscal and pension finances. … Also, try to build up your own nest egg as much possible. … Have what I call a ‘plan B’ or a backup system in case pensions in your state are cut.”