Friday, June 22, 2012

Carrot and Stick Treatments of Pension Sponsors Not Working, Analyst Says

We have been contending that many of the pension systems in an underfunded condition are so because their city or state sponsor did not make their contributions in a complete and timely fashion. Their sponsor’s delays have reached their day of reckoning in many places.

The State of Texas has been pretty good at setting aside enough money to fund its employees’ pensions, but not perfect. For example, over the last six years Texas has fully funded the actuarial required contributions (ARC) for its Teacher’s Retirement Systems twice, and contributed 85% of its requirement in the other four years. Clearly, this puts the pension in jeopardy of achieving comfortable rates for its funded status, but it’s much better than other states that tend to only contribute half – or less. Other states’ pensions with funded status in the 20-40 range are increasingly becoming a national wake-up call for make-up contributions that need to be made diligently, and fast. The sad thing is that the politicians who had engineered the shortfalls don’t suffer because of it. They used the money that was available to them to pay for other constituency services, the type that gets them re-elected. But the retirees who contributed their life to public service and promises of a secure retirement (many without Social Security) suffer anxiety in seeing the topics of their retirement benefits get bandied about as a political football.

Well, it’s time the engineers of the shortfalls had their comeuppance too, according to an actuary who follows these matters closely.

Pension analyst Chris Tobes has an interesting take on the reasons that public pensions have experienced underfunding, as well as the serious shortcoming of the current systems of “checks and balances” as they could be said to exist in the pension world. Here’s a couple of paragraphs from his most recent paper, “Did the SEC and S&P let 14 states destroy their Pensions?”:
14 States have broken balanced budget clauses of their own constitutions in addition to defying the rules of pension mathematics. According to data from the Center for Retirement Studies at Boston College: Illinois, Kentucky, Oklahoma, Rhode Island, Connecticut, Colorado, Alaska, Minnesota, New Jersey, Kansas, New Mexico, Pennsylvania, Maryland, and Missouri have made partial payments over the past 7 years. In my attachment you will see how they have made the equivalent of half the mortgage payment for 10 years which has been the main driver taking their funding ratios into the 20,30s and 40s, and proves these are self-inflicted wounds. Even in bull markets some of these funds shrink in assets because of negative cash flows.

I contend that ratings agencies (S&P and Moody’s and Fitch) and the SEC are enablers by allowing this partial payment culture to exist and not punishing states and localities enough for not making their ARC. If States had paid half their municipal coupons the rating agencies would have downgraded them, but they looked the other way with pensions. The SEC caught New Jersey red-handed in 2010 but only gave them a slap on the wrist.
First, note that Texas is not among the states Tobes mentions.

Next, note that Tobes makes the case that those other states’ credit agency assigned ratings should have suffered when the state sponsors put their pension obligations on a non-existent credit card – and didn’t disclose that to investors. If a state only pays half of what is needed to keep a system sound, there will be a day of reckoning, and those half-payments weren’t appropriately calculated into the rating that affects a state’s ability to borrow money. Credit ratings affect borrowing costs. If the credit agencies had done their job in adjusting their ratings to the unfunded liabilities, the sponsors may have more diligently balanced their pension obligations with expenditures for current services. If the credit ratings had been downgraded appropriately, the markets would have been able to send signals to investors about the risks involved and appropriate bond pricing that continues to go higher may have likely woken sleeping taxpayers.

Tobes’ analysis is interesting because it demonstrates the disparities between private and public sector pensions. Private sector pension sponsors would have suffered immensely under ERISA laws designed to monitor their ongoing funding. No such monitoring exists for public sector sponsors, except through the credit rating agencies. They need to do their job so that more responsible behavior can be achieved throughout the system, even by politicians. – Max Patterson

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