Pension Problems

Nearly 28,000 employees currently work for the state of Mississippi.  For each employee hired, the state makes a promise to pay that employee a pension at retirement as long as the terms of employment are met.  The program is known as the Public Employee Retirement System, or PERS for short.  Mississippi isn’t unique; other states and corporations make similar promises.  

What is the cost of that liability to the employer? 

Jeremy Gold, an economist and one of the first actuaries on Wall Street, spent most of his life trying to answer that question.  He joined Morgan Stanley in the 1980s and became obsessed with the questionable math being used to value pension promises. Gold felt that modern pension accounting was miscalculating the true cost of pension liabilities, so he returned to school to learn more.  Gold enrolled at Wharton School of Business, obtained a PhD in 2000, and became an outspoken critic of pension liability accounting.

Eventually Gold’s crusade gained traction and found support from Moody’s Investors Services, a well-known Wall Street rating agency.  Moody's altered their own method of pension calculation in 2013 in light of Gold's findings, giving us a better picture of the situation today.

So, why does any of this matter? 

It appears that Gold may have been correct in sounding the alarm.  The gap between ‘money needed’ and ‘money in the bank’ has grown considerably in recent years for many states and municipalities.  CNN Money and Pew Research reported that the overall shortfall in state budgets is currently $1.4 trillion. 

Let’s use Mississippi as an example.  To be 100% funded, the state of Mississippi would reportedly need current assets of $42.5 billion growing at 7.8% annually to meet its pension liabilities.  However, the state’s pension fund has only $24.5 billion, a short fall of roughly $18 billion.  In other words, Mississippi only has 58% of the money it actually needs to meet the state’s pension promises.  By the way, they rank 38th compared to other states according to Pew Research.  The national average is 66%.

A more alarming consideration:  the gap between what pensions need and what they actually have has widened in recent years DESPITE the great stock market performance over the past 10 years.  In 2015-2016 (the most recent data) the funding shortfall reportedly increased by nearly $300 billion.  To be fair, low interest are the main culprit for the widening gap as they factor mightily into the calculation of ‘money needed’. 

Current employees nearing retirement likely need not be concerned with the short fall.  The situation is concerning, but it is, in essence, a math problem.  Still, a solution will need to be reached sooner rather than later for new hires to enjoy the full promise of a pension.  Taxes will likely need to increase and/or future promises may be muted. 

Jeremy Gold passed away last month from leukemia at age 75.  Forbes and the Wall Street Journal were among the many publications that ran a story about his life.   Gold’s lasting impact is two-fold, he raised awareness that: (1) changes need to be made to pension funds, and (2)  retirees need to have a backup plan beyond the promise of a pension.  Investors can still create a “pension” like income stream with other investment vehicles, but formal pensions are slowly become a smaller element in retirement planning. 

The most important takeaway from this information should be the increased importance of external savings.  For our younger clients, don’t dismiss the importance of IRA contributions rather than relying on the promise of a pension.