U.S. States Fudge Pension Numbers: Research
Off-balance sheet liabilities almost triple what is reported on bond markets.
June 22, 2010
Federal deficits in the U.S. worry markets, not least because of the looming draw on entitlement programs such as Medicare and Social Security. Social Security, unlike CPP, is not separately managed by an independent board monitored by an actuary. Instead, payroll taxes flow into general government revenues, while notionally being allocated against future liabilities.
State deficits tend not to be so worrisome – simply because most states are required by their constitutions to balance their budgets annually. Except that they carry significant liabilities – off their balance sheets. They include public pensions.
According to Joshua Rauh, a finance professor at the Kellogg School of Management at Northwestern University in Evanston, Illinois, those off-balance-sheet liabilities are more than triple the debt they officially acknowledge on the bond markets.
Even if those pension plans achieve their discount rate – an 8% annual return – many states will be in the red within the next 20 years.
“Based on September 2009 asset values” Rauh writes, “if state pension fund asset returns have an average return of 8% going forward (the states’ typical assumption), states in aggregate will run out of funds in 2028. If average returns are 10% through 2045, the funds in aggregate will be roughly sufficient to cover liabilities to existing workers under the states’ actuarial assumptions. If average returns are only 6%, state funds in aggregate will run out in 2024.”
Some states face particularly grim calculations, he notes:
“Assuming 8% asset returns, Illinois would run out in 2018, followed by Connecticut, New Jersey, and
Indiana in 2019. Five states never run out, including New York and Florida, and 17 other states have a horizon of 2030 or beyond. If all states experience 8% average returns, 20 of the states will have run out of pension money by 2025. If the average returns are 10% then only 11 will have run out by 2025. If returns are 6% then 31 will have run out by 2025.”
Some might suggest that an 8% return is an heroic assumption for a 60/40 portfolio. It’s certainly worth debating, after the “lost decade in stocks.”