To Save Defined Benefit, Unions Need to Accept Investment Realities

Editor’s Note: The president of the California Professional Firefighters union, Lou Paulson, has criticized Mayor Chuck Reed’s pension reform, stating “His idea of pension reform is, you sign up for one pension system, we’re going to change it now in mid career, and now you’re going to get something different.” But Paulson, and anyone who thinks defined benefit pensions can remain financially sustainable with only incremental adjustments, is ignoring a potential “mid-career” imposition of “something different” that could hit these funds like a seismic wave – a severe and prolonged market correction. That has already happened twice in the last 20 years, and each time, the rebound was triggered by lowering interest rates. But how much lower can interest rates go? In the following article by UnionWatch contributor Mike Shedlock, he highlights a just released forecast by GMO, a global investment management firm, that projects real rates of return for stocks and bonds stagnating at near zero levels for the next several years. What if they’re right? Shedlock’s article goes on to describe the situation with Illinois state pensions. The situation in California is scarcely better – after a bull market lasting nearly eight years, California’s state and local pension funds are still a bit shy of 80% funded, which is considered the minimum level for a healthy pension system. Saving defined benefits will require adopting much lower rate of return projections, and returning benefit formulas to pre-1999 levels. The sooner the leaders of government unions accept and support this, the more likely they will be able to save the defined benefit for all their members.

It is extremely refreshing to see a large, prominent, and historically accurate fund manager lay it on the line.

GMO does that quarter after quarter, with no-nonsense projections.

As of March 31, their 7-Year Asset Class Real Return Forecast is as follows.

GMO 7-Year Real Return Forecasts by Asset Class

2015 through 2021

Serious Question for Pension Plans

Given pension plan assumptions of 7-8% annualized returns how many of them can survive negative returns for seven years? It’s important to note that GMO is talking about “real” inflation-adjusted returns with an assumption of mean-reversion inflation to 2.2% over 15 years.

Still, that leaves US equities at zero to -1% returns and US bonds at negative 2.4% returns.

Even if GMO is wrong by say 3%, many pension plans will be in deep serious trouble at those returns.

Illinois Pension Plans

I keep harping about this issue, but it’s an important one. In the state of Illinois, and in spite of an enormous rally in the stock market since 2009, Illinois pension plans are only 39% funded.

A “Special Pension Briefing” last November, shows the Illinois State Retirement Systems are in dismal shape.

Unfunded Liabilities

• Teachers’ Retirement System (TRS): $61.6 Billion
• State Retirement Systems (SERS): $61.6 Billion
• State Universities Retirement System (SURS): $21.6 Billion
• Judicial Retirement System (JRS): $1.5 Billion
• General Assembly Retirement System (GARS): $0.3 Billion

The above numbers show actuarial (smoothed) asset valuations.

Liability Trends – Not Smoothed

Illinois State Pension Systems Combined

Unfunded Liability History 2000 – 2014 ($=B)

In spite of the massive stock market rally, Illinois liabilities increased every year since 2011.

For still more details, please see Illinois Pension Plans 39% Funded; Taxpayers On the Hook for $105 Billion in Liabilities; It Will Get Worse!.

Any notion that pension shortfalls can be balanced on the backs of Illinois taxpayers needs to vanish now.

How did Illinois plans became so underfunded?

In general, by promising far more than can possibly be delivered.

Illinois State Pensions – Summary of Liabilities and Unfunded Ratios

Congratulations go to the Illinois General Assembly Retirement System (GARS) for having one of the worst, (if not the worst) pension plan in the entire nation. It is 16% funded.

No doubt, that increases the pressure of the General Assembly to put the burden of bailing out the system on the backs of Illinois taxpayers.

Fraudulent Promises

Pension promises were not made in good faith.

Rather, pension promises were the direct result of coercion by public unions on legislators, mayors, and other officials willing to accept bribes because they shared in the ill-gotten gains of backroom deals at taxpayer expense.

Illinois taxpayers cannot be held accountable for coercion of public officials by public unions. Fraudulent promises will be held “null and void” in any “non-stacked” court of law in the nation.

Given the 31% funding of the Illinois Judicial Pension Plan (JRS), the sorry state of Illinois pensions is likely headed to federal courts.

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About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.