The True Cost of Generous Pensions
We have seen the future, and it costs. When unions and employers talk, they quickly agree on generous pensions for workers. Why? Future employers will pay for them. Today’s employers will get credit for generosity and never even get a bill.
For example, the Chicago Teachers Union negotiated a pension averaging over $73,000 per year, over 90% of a teacher’s salary, according to the Illinois Policy think tank. Today, Chicago’s pension fund endangers the fiscal health of a city whose bonds already have been graded as junk. I’ll explain how this can happen to Nevada, too. For now, bear in mind the moral of the story: Pension funds must beware of investments that sound too good to be true.
Most pension plans are pay-as-you-go: Current workers pay for current retirees. But when the evil day comes to pay for the generous benefits, the boss will naturally balk at taking more out of the paychecks of his current workers. Instead, he usually pays by investing in stocks and bonds that deliver high returns. For example, he may buy cheap stock in a new company like Nvidia and then sell it at a high price as the firm becomes well-known. The sales proceeds pay for pension benefits. Or he may buy stock in a long-established firm like Verizon and spend the dividends on benefits.
However, the return on such assets is high partly because they are likely to fail. Consider a shaky company that borrows by selling a 20-year bond. The firm may go under in a few years and never pay off the bond. Knowing this, the bond buyer will demand a high interest rate today to compensate for the risk. This is the kind of bond that the pension fund buys. Thus, pension funds, which are supposed to provide a secure income, are surprisingly likely to fail.
This problem is severe today because of demographics. The Baby Boomers—the generation born between 1946 and 1964—are collecting pensions. As the number of workers per retiree decreases, the pension burden on today’s workers increases. In Nevada’s public pension fund, the number of workers per retiree fell steadily from 2.1 in 2013 to 1.6 in 2023, according to the Nevada Public Employees Retirement System.
If the government is responsible for the fund, taxes must rise to pay this increasing burden. If companies are responsible, they may raise prices to generate more revenue or cut costs to free them up. In any case, a growing pension burden raises taxes, prices, and unemployment and lowers wages.
These implications are dire for Nevada. True, in any given year assets exceed liabilities in the state’s pension fund—a difference known as “net position.” In that sense, the fund is in good shape financially; however net position fell $4 billion in 2021 to $54.5 billion due largely due poor investments.. The fund’s assets cover only three-fourths of its liabilities actuarially speaking..
In other words without reform or miracles,,the fund might eventually go broke without help from taxpayers.,A lot help at that..In fiscal year 2023,,the owed $18 .3 billion altogether according annual report.,If paid off debt one year would claim three-fifths tax revenues shutting down many state operations including police posts road repairs..
As grim possibilities what grimmest we don’t know what happen..For example gross liabilities fell roughly three-fifths because paid trades stocks bonds according annual report..Such trades notoriously unpredictable..Nevada net position rose much had fallen prior year thanks surprising comeback stock market...In short fog fills crystal ball liabilities...
Payments also hard predict fluctuate...Volatility payments into four times safe amount (12% versus %)...Volatility range between employers’ largest smallest payment rates...
The boss usually pays fixed percent worker’s salary into ...But if firm trouble cut salary thus paying less...If contribution falls unexpectedly low shipwreck...For example if goes bankrupt no longer anything sum uncertainty about payments lead catastrophe...
Luckily payments by employers governments contributions usually predictable...Unluckily 98% assets not contributions but stocks bonds according annual report...The sales value careen wildly...
For example return investments fell from %21 .5 fiscal minus %5 .1 according reports....US international US collapsed mild recession....Indeed almost half portfolio US stocks most recent report....
Stocks much riskier than long-term Treasury because firms broke while government almost certainly never will...(Why not? Because world demands dollars Washington issues People accept dollars just about anything It universal money) Managers focus portfolio because return %20 according annual report To see why impressive imagine got %20 raise every year!
By contrast return both those issued negative right now You more than back interest Because concentrated earns high rate But risky They won’t forever...
Because takes risks Pew Charitable Trusts said Silver State one failed meet benchmark survival bleak prognosis might partly stem failure stress-test regularly...
The good news if called funded ratio stable since according Pew Trusts able cover three-fourths debt contrast most states’ fallen about one-eighth Most having more trouble before paying bills Not situation tells us where been going....
To foretell look ratio net payments assets operating cash flow shows how long continue without going broke ratio -%1 .5 That payments out minus were %1 .5 This not severe drain worth fact above usual benchmark fiscal stress which –%5 However measure pays no attention major source income—investment stocks So don’t excited...
The operating cash flow excludes investment returns tells us how long could continue relied only “safe” contributions which payments Related measure considers investments Net amortization concerns whether contributions cut debt perform expected answer Contributions skimpy pare has paid out more took since least gap increasing reports...
In sum does not look sustainable Sustainability means long run revenues match spending debt increase...
This problem unique Across country investment returns provide %60 Pew Trusts projects rate fall below assumed plans targets event take less expected even fail cover debts addition rates change dizzying speed from %27 .3 -%5 .1 probably reliance tempestuous bonds....
We achieve sustainability two ways One cut raising retirement age cutting benefits It sort thing led French voters reject President Emmanuel Macron party summer Other way make productive afford growing tightening belts course everyone prefers Option Two However given system policy directly affect amount typical produces If want policies raise productivity must scuttle compel save induce produce also subvert purpose guarantee comfortable retirement depends savings depends salary living expenses interest rate substantial extent cannot control factors Therefore comfort guaranteed....
Retirees want both comfort security should recognize tradeoff But emphasize comfort try boost regardless sudden decline income failing assets pays lip service tradeoff “One principal goals Public Employees’ Retirement Board stabilize contribution rates during volatile investment market cycles demographic changes ensure cost predictability employers members,” writes Tina Leiss executive officer popular annual report reports predictions long-run far below target exposing risk....
Nevada instructive example Chicago where public debt rose by $1 .8 billion past City Council earmarked $307 million interest Had existed money could spent instead hiring teachers ten years calculations financial reports case severe than because assets cover only fourth covers three-fourths root problem same Underestimating revenues needed benefits occurs officials keep eyes blissfully shut finance department four-page letter Mayor Brandon Johnson accompanying dwelled facts such third-largest American did say word commission reform failed devise plan Surely Nevadans savvier