Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Peloton 35% CRASH a Lesson of What Happens When One Over Pays for a Loss Making Growth Stock - 1st Dec 21
Stock Market Sentiment Speaks: I Fear For Retirees For The Next 20 Years - 1st Dec 21 t
Will the Anointed Finanical Experts Get It Wrong Again? - 1st Dec 21
Main Differences Between the UK and Canadian Gaming Markets - 1st Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - 30th Nov 21
Omicron Covid Wave 4 Impact on Financial Markets - 30th Nov 21
Can You Hear It? That’s the Crowd Booing Gold’s Downturn - 30th Nov 21
Economic and Market Impacts of Omicron Strain Covid 4th Wave - 30th Nov 21
Stock Market Historical Trends Suggest A Strengthening Bullish Trend In December - 30th Nov 21
Crypto Market Analysis: What Trading Will Look Like in 2022 for Novice and Veteran Traders? - 30th Nov 21
Best Stocks for Investing to Profit form the Metaverse and Get Rich - 29th Nov 21
Should You Invest In Real Estate In 2021? - 29th Nov 21
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Multi-Trillion Dollar Black Hole That Could Undermine the U.S. Economy

Economics / US Economy Jul 30, 2012 - 05:11 AM GMT

By: Money_Morning

Economics

Best Financial Markets Analysis ArticleShah Gilani writes: The difficulties facing retirees aren't just their problems. Underfunded pensions weigh down everyone's retirement expectations and America's future growth prospects.

Kicking the can down the road on this one has involved everything from outright lying to misrepresentation, bordering on fraud in the way pension plans calculate their liabilities.


If long- term solutions aren't implemented, the U.S. economy will experience a secular decline, equities will plummet, and millions of Americans of all ages will suffer.

While huge problems exist in private pension plans, public-sector plans -- those slated to provide retirement benefits to public-service employees of state and local governments -face exponentially larger problems.

Here's a look at what the problems are, who's responsible for the mess we're in, who's going to have to fill in the deep holes, what the bad news is when it comes to fixing pensions and what the worse news is if they aren't fixed.

A Multi-Trillion Dollar Hole
A recent S&P Dow Jones Indices study highlighted record levels of pension underfunding at publically traded companies in the U.S.

At the end of fiscal year 2011, according to S&P, corporate pension plans were collectively $354.7 billion underfunded based on obligations totaling $1.676 trillion and assets of $1.322 trillion.

In addition, S&P noted that OPEB promises (Other Post Employment Benefits) such as health related benefits and life insurance were $233.4 billion underfunded.

To some extent the private sector's pension woes are ostensibly offset by the more than one trillion dollars of cash sitting on corporations' balance sheets.

But the problem with that cash is that it's not being earmarked for pensions.

Managers are stashing cash for any potential global rainy days ahead, for strategic acquisitions and as a cushion against an expected peak in the earnings cycle. But none of the officers or executives of any corporations sitting on mounds of cash have indicated any intention to fill pension holes with their coveted cash hoards.

On the public sector side of the pension plan dilemma, things are exponentially worse.

Actuaries, the professionals who calculate the life expectancy and needs of pension beneficiaries and the level of assets and expected returns on plan assets necessary to meet promised obligations, estimate the shortfall at more than $1 trillion.

But that's a far cry from the $4.6 trillion shortfall figure that some economists and analysts have levied as the true liability picture.

The difference isn't a guess. It's based on real math, which makes it frighteningly clear that even the $4.6 trillion liability figure woefully underestimates the depth of the hole.

Pension Fund Pressures
There are two components that determine a pension plan's assets.

Annual required contributions (ARC), the expected cash investments made by employees and employers, and the return-on-investment on those assets together determine the health of pension plans.

Annual contributions are a problem for both private and public sector plans.

Corporate woes and cash- flow issues may result in underfunded employer contributions.
Additionally, employee contributions are a function of the size of workforces, which decrease usually at the worst time in an economic cycle, causing fewer contributors to bear the burden of increasing obligations.

It's even worse now in the public sector.

Deficit reduction pressures are sinking federal, state and local employment rolls at the same time that tax bases are narrowing.

In effect, fewer government employees, at all levels of government -- federal, state and municipal -- are contributing to pension assets as retiring and laid-off workers add to budget woes and pension liabilities.

To make matters infinitely worse, government leaders and legislators have raided pension plans to pay for spending projects. They've also tapped pension funds in many backroom deals to show balanced budgets and offer more tax cuts and services to the voting public.

But the ailing contribution side of the two-pronged asset equation pales in comparison to the willful and almost criminal misrepresentation of expected returns on plan assets.

Expected Returns Meet Reality
Most pension plans use an expected 8% (blended) return on assets under management to determine future asset streams sufficient to meet obligations.

The 8% figure used to be the historical annual average return that was expected to continue into infinity.

Then reality intervened. Markets sank, crisis after crisis decimated equities as well as the economy, and the Federal Reserve began an articulated policy prescription of the decades-long depression of interest rates.

The reality may be that, on a good day, based on an acceptable risk profile given the absolute requirement for positive returns to meet retiree living expenses, a 4% return is the best pension plans can assume under current circumstances.

Actuaries, as a matter of shorthand, call the expected return they apply to plan assets the "discount" figure. In other words, though in strict finance theory terms this is not how it's calculated, a discount of 8% implies an 8% return on investments.

As this excerpt from the "Report of the State Budget Crisis Task Force" explains:

"One of the actuary's critical jobs is estimating the liability that a pension system has to its beneficiaries. This requires projecting benefits that will be paid in the future and "discounting" those benefits to the present. The choice of discount rate is critical.

For example, the estimated liability today for a single-year's pension benefit of $31,700, payable 15 years hence, is approximately $10,000 using an 8% discount rate, but more than $15,000 using a 5 % rate.Put differently, using a 5% rate increases the estimated liability by about 50% relative to an 8% rate.The impact on unfunded liabilities can be dramatic.

In the example above, if a pension plan had $8,000 in assets set aside for the future benefit it would have unfunded liabilities of $2,000 at an 8% discount rate (given the liability of $10,000). But with a 5% rate the plan would have $7,000 in unfunded liabilities (given the liability of $15,000) - the unfunded liability would be more than three times as large."

As for an 8% return, plans aren't close to achieving it and haven't been for more than a decade now.

Experts calculate that a 1% drop in the discount rate can lead to a 10-20% increase in the present value of pension plan liabilities.

A Crisis in the Making?
As all this is coming to light, the Government Accounting Standards Board (GASB), responsible for government accounting of pension plans, is changing the rules.

It's going to require pensions with less than 80% funded plans to discount short-funded balances at 3-4% rather than 7-8% as they are calculating now.

Moody's, citing accounting changes and the impact that will have on pension plan liabilities, states and localities, has issued warnings that credit downgrades are sure to follow.

C orporations can escape some of the burdens of pension obligations through bankruptcy, selling off divisions, restructuring and other tactics, and hand off future obligations and their financing to the Pension Benefits Guarantee Corporation (the 1974- enacted pension bailout fund that's financed by premium payments from beneficiaries whose plans collapsed and were taken over by the PBCG). But public sector pension plans don't have it so easy.

Deficit reduction demands, increasingly volatile and narrowing tax bases , an uncertain economic future, and the dreaded fiscal cliff are wreaking havoc with pension funds and Americans' retirement prospects.

In the short run, if long-term fixes are put in place, there will be pain. Retiree benefits in general will have to be cut. Contributions from employers and employees will have to increase and payout amounts may in the future have to fluctuate with real returns.

But we'll get through, and knowing that a good, honest and realistic fix is in place will set the stage for greater employee confidence and productivity.

On the other hand, if there is no fix in our foreseeable future, markets will start discounting the prospect of less well-heeled retirees and slowing consumer demand.

A market crash based on the fiscal cliff crumbling on top of underfunded pension plans would compound future return prospects for both pension plans and America's future.

Something has to be done now.

Source :http://moneymorning.com/2012/07/30/underfunded-pensions-undermine-the-entire-economy/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in