The Municipal Pension Payment Curve

This article was originally going to be titled, “Dying Cities, Dying States, Dying….”  I thought that would be correct but too pointy.  The key to thinking about pensions is to look at the likely cash flows for current and former employees.

Here’s my scenario: a municipality decides to terminate its overly generous defined benefit [DB] plan, and though it is 30% underfunded, they agree to not let underfunding get greater than 30%.  Sadly, the discount rate on the pension cash flows is 8%/yr, but the likely investment earnings rate is 6%/year.

Here’s the graph of pension payments to beneficiaries, and contributions to the plan:

Pension Payment curve_14804_image001

At the beginning of this scenario, pension payments were 10% of the municipality’s budget.  Assuming taxes only grow at the rate of 2%/year,  contributions to pensions are not less than 10% of the municipality’s budget until 2049.  As a share of the budget, it peaks out at 32% from 2032 to 2035.  It’s over 20% from 2022 to 2043.

30% underfunding isn’t that uncommon, and discount rate assumptions of 8% aren’t that uncommon either.  Would that all municipalities were at discount rates of 6%, or at my more likely view, 4%.

But it doesn’t matter.  We can argue over assumptions.  The cash flows actually paid to beneficiaries do not rely on assumptions.  The assumptions exist to try to allow pre-funding, so that municipalities fund their plans to the same degree that benefits are accrued.  Some municipalities have done that with pensions, almost none have done it with retiree healthcare, but the retiree healthcare promise is much weaker one.  You can turn it from a Cadillac plan to hospice care, in many cases.  In this case the state constitution matters a great deal, so do your own homework here.

Part of my advice to you is to watch weaker states and municipalities, like Puerto Rico, Illinois, Chicago, Pittsburgh, and many others.  I don’t have all of the data in front of me.  This is one of those cases where relative standing is important.  People will migrate out of areas with low funding, and high expected payments, and into municipalities with higher funding, and lower expected payments in relative terms.

You will see municipalities depopulate, because the taxes are disproportionate to the increasingly slim services rendered, because much of the revenue pays for the overly generous past promises to retirees.  As a result, you will see more municipal bankruptcies.  I would expect that you would see most of the bankruptcies in the 2020s.

I know that’s vague, but I think it is more defensible than Meredith Whitney’s notable statement a few years ago.  The pension cost curve is inexorable, and I suspect most municipalities can bear it for the next six years, but will have a hard time with it as the tail end of the Baby Boomers retires in the 2020s.

Advice

1) If you are in an area under pension stress, if you at all can, not harming your existing earnings, move to an area not under that stress.  Remember, as other people move, it will become increasingly difficult to maintain existing services.  Think of the slow police response times in Detroit, and packs of stray dogs that roam the city.

2)  If you work for a municipality, consult your state constitution to see what you are guaranteed.  In many cases, healthcare will not be covered.  Even existing pension benefits in payment now may be under threat in a default.  Be aware.

This is one of those cases where the rich will get richer, and the poor will get poorer — better to be on the rich side of the line, and sooner.

Final Note

All that said, we face the same issues with Social Security and Medicare, though both are unfunded.  At present, Social Security’s payments will be cut by 25% or so in 2026, unless some adjustment is made to the system.  Medicare is another issue, and the question is what will it cover.  It could be stripped back a great deal when the US realizes it can’t fund a generous system that extends life a few years at high cost.

My main point to all of my readers is to be aware of the imbalances in the existing systems, and be ready for the coming adjustments, because the US economy will not be willing to make all of the payments that have been promised to oldsters who have served the public.

3 Comments

  • Greg says:

    David — I understand you are trying to be diplomatic in your posts, but there is a difference between putting a positive spin on an issue, and deceiving yourself (ourselves).

    “We the people” already defaulted on these promises. “We” made all sorts of promises, but (at best) underfunded those promises. In all too many instances, promises were made with no money set aside to make good on the promises.

    A good rule of thumb in business, life and the Watergate mess in the 1970s: follow the money…

    If these so-called promises were half as sacred as today’s shrills are claiming — they would have been funded all along.

    No one ever planned to make good on these pensions. Spout all the rhetoric you like. Read my lips, have sex with your intern, yadda yadda yadda.

    If anyone really thought these pensions should get paid — “we the people” would have funded them.

    We all see the half @ssed job government “workers” do. Sure, there are exceptions that prove the rule, but most government employees are lazy, unproductive, arrogant, and overpaid even before considering their obscene benefits.

    To paraphrase a favorite saying of the Russian people under the Soviet system:

    Public employees pretended to work, and we pretended to fund their pensions.

    • My main goal is to try to explain what will likely happen and when, so that many people may appraise the danger and make adjustments now, not 10-15 years from now when the cash payment curve is whacking everyone between the eyes with a 2×4.

      Being “diplomatic” is to me being fair to my audience. Also, I serve on boards that might not like me so much if I put things in the rawest way. I try to be a gentleman.

      • Greg says:

        When one tries to be nice and avoid all confrontation, one runs the risk of being an enabler (to use alcoholic’s anonymous’ diction) or an appeaser (to use world war two policy diction).

        History shows Lord Chamberlain was quite the gentleman, while Winston Churchill was told to tone down his rhetoric.

        Short attention spans of the media aside — there have been lots of people who have warned about unfunded promises for decades. Many (most?) tried to phrase things as nicely as possible.

        We the people saw that we were not funding the promises the politicians were making. We understood the promises would not be paid unless we funded them. And after hearing and understanding the above — we voted (many times) not to fund the promises. This decision was made by “we the people” in both red states and blue states, during many elections, spanning many decades.

        “We” already voted to default. Long ago.

        Public employees pretended to work, and we pretended to fund their pensions.

        Gentlemen should not attempt to thwart the will of the majority, even if they sit on boards tasked with keeping up the charade.

        Your job as a board member is to keep lying to the public employees — keep telling them to work 25-30 minutes a day. Someday in a land far far away, a magic fairy will appear and let them retire with full pay after only 20 years while the public they were supposed to serve has to work 45 years for the same benefit (which in many cases is being devalued or taken away).

        Board members should keep telling the public servants that public pensions are guaranteed even though the public’s are not.

        Appeasement is a great policy. Let the next guy worry about the consequences.