In-Depth: Public Pension Research

MBPA Principals on Public Pension Research

The Market Challenge of Underfunded Public Pensions

Many states, local governments and governmental agencies are struggling under the weight of their pension plans, which oversee the retirement incomes of current and past public sector employees.

The scale of this pension crisis, as it has been dubbed, is huge. The Hoover Institution, a think-tank at Stanford University, estimates that US public pensions collectively have a $3.4 trillion funding hole. 

Few public pension plans are fully funded, meaning they do not have enough money to pay current and future retirees. And the situation is getting worse.

According to Wilshire Consulting, an investment advisory company, state-sponsored pension plans in the US had just 73 percent of the assets they needed in mid-2015, down from 77 percent in 2014. Turbulent market conditions in the latter part of 2015 and early 2016 probably made this number even worse.

The big questions are if and how the large funding holes that have emerged in the US public pension system can be fixed.

Tamara Burden, principal at Milliman Financial Risk Management, an investment adviser to pension funds, says: “Raising taxes and issuing bonds means a vote, and a lot of public entities have seen those initiatives not pass.

“[The large-scale underfunding of public pensions] is really hard to fix.”

In Chicago, Ed Bachrach, chairman of the Center for Pension Integrity, a non-profit organization, estimates that to ensure the city’s pension plans are fully funded within 20 years, Chicago’s property tax would have to be increased 85 percent. But he warns that “crippling tax increases” could drive taxpayers and businesses away.

Mr. Bachrach adds: “In troubled jurisdictions, officials cannot raise taxes fast enough to prevent the erosion of fund assets, and the enormous pension payments required are crowding out expenditure for vital public services and crumbling infrastructure.”

The large funding holes that have emerged at US public pension plans have been decades in the making.

A combination of factors, ranging from demographics to current low interest rates, has left pension plans nursing big deficits.

In some cases, cities and state governments have not contributed as much as they should have to public pension plans, leaving funds without the money they needed to invest and plug any developing funding holes.

Another factor is that public pension plans have been underestimating how much money they would need in future, says Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania.

Public plans typically have high return targets of between 7 and 8 percent, which are used to forecast how much money a pension fund will need to pay current and future retirees. Private sector pension plans, in contrast, typically use lower rates of 2.5 percent on average to calculate future liabilities, says Ms. Mitchell.

Every time a public pension plan misses the return target, their liabilities jump. They then need far stronger performance the following year in order to correct the problem.

An ageing public sector population is not helping matters. “There is no young blood coming in to keep their plans going,” says Ms. Mitchell.

MBPA’s Public Pension Research as Leverage Against Portfolio Loss

MBPA can help you protect your municipal bond portfolio investment in the following manner:
MBPA provides extensive research into both State as well as local pension plans.
MBPA provides custom research for both the private and institutional investor.

Private Investors - Individual private investors are better equipped to avoid possible land mines as it pertains to their municipal bond portfolios from credit rating declines and in some extreme instances possible credit defaults by leveraging MBPA Public Pension Research.

Institutional Investors - Institutional municipal investments can leverage MBPA Public Pension Research to avoid possible portfolio losses.

Worth T. Blackwell, Principal
H. Gilmer Nix, Principal
Andrew V. Pittman, Principal

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