This is my second column for the Illinois Policy Institute, where I am now a senior fellow.
The article was written well ahead of the Moody's downgrade of Chicago pensions last Friday, with a final edit made on Friday, and posted then on the IPI website.
Illinois Pension Plans 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, as does the following chart.
Summary of Liabilities and Unfunded Ratios
click on any chart for sharper image
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.
Smoothed Returns
The above chart shows "smoothed returns" that even out the 2007-2009 dip as well as the 2010-2014 blast higher. Illinois resorted to using "smoothed returns" to minimize the effect of the 2007-2009 dip. But now, with the rally, Illinois wants to use actual market returns.
On a non-smoothed (market) basis the numbers are slightly better. Non-smoothed, the total deficit is $105 billion instead of $111 billion.
Liabilities Per Household
Let's be generous and assume the lower $105 billion number. The US Census Bureau shows there are 4,772,723 Illinois households.
The potential taxpayer burden to make up the deficit is $22,000 per household. That's not even the worst of it as the following chart shows.
Liability Trends - Not Smoothed
In spite of the massive stock market rally, Illinois liabilities increased every year since 2011.
Expectations
Zero Percent Chance of Success
Its bad enough that Illinois is $105 Billion to $111 billion in the hole and liabilities have increased in spite of a massive rally in both stocks and bonds.
Illinois plan expectations are icing on the "Zero Percent Chance of Success" Cake.
I discussed this at length in my post Beggar Thy Taxpayer: Currency Wars, QE Strain Life Insurers and Pension Plans; Negative Returns With 4-7% Promises.
Europe vs. US
In Europe, pension plans and retirement funds have promised 4% returns. Future promises in Germany are now down to 1.25%. However, yields on 10-year German bonds are 0.35%.
In Illinois, the plan assumption for TRS, the biggest system with the biggest unfunded liability, is 7.5%. There has been no meaningful reduction in plan promises over the years.
7.0% to 7.5% Assumptions Will Not Happen for Two Reasons
- US Treasury Yield Curve
- Stock Market Valuations
US Yield Curve
US Promises
In the US, pension funds have not made 1.25% promises or even 4% promises, but rather 7.0%+ promises with the 10-year bond yielding about 2%. Annuities promise 6% or so.
Illinois promises range from 7.0% to 7.5%. How you get 7.5% in a 2% world?
The correct answer is: you don't. But insurers and pension plans try, by taking risks. And the more risk they take, the higher and higher into bubble territory go stock market and junk bond valuations.
This is well understood and established behavior. And it's precisely what the Fed has sponsored. At the end of 2012, even mainstream media recognized what was happening, as shown by the following quote from the CNBC article How the Fed Is Pushing Investors to Buy Junk Bonds
"The market is thirsting for yield and the Fed is pushing people to do things like this [buy junk]," said Lawrence G. McDonald, who as head of LGM Group specializes in junk-bond trading. "So big asset managers are reaching, reaching, reaching and companies know this and are issuing, issuing, issuing all this crap."
We have seen that effect in Illinois pension plans as well. In our own report, 401(k)s are better than politician-run pensions, we noted pension funds often invest in riskier assets to try and boost their returns.
"A look at the Illinois Teachers’ Retirement System, or TRS, portfolio, for example, reveals a portfolio of investments in junk bonds, real estate, derivatives and private equity. TRS has more than $1 billion invested in bonds that Moody’s Investors Service or S&P Ratings Services rate as junk."
Seven Year Negative Returns
As of January 31, 2015, Stock and bond prices are so stretched that GMO's 7-Year Asset Class Real Return Forecast shows negative real returns for seven years in US equities and bonds.
"The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years."
As of December 31, 2014 GMO managed $116 billion in assets.
Broken Model
In the US, pension plans have aggressively shifted from investing in AAA rated bonds to equities and junk bonds because yields in US treasuries and AAA rated corporates are not high enough.
Denial that this has happened is nearly everywhere one looks. Of course the Fed, and most others, cannot and will not see a bubble until it bursts wide open.
Even if the air is let out slowly (something that has never happened in practice), negative real returns, and perhaps zero nominal returns for seven years are the only other plausible outcomes unless one expects an even bigger bubble coupled with even longer negative returns in the future.
Simply put, numerous US pension plans are in deep, deep trouble. Illinois is at the top of the list. Plan assumptions cannot and will not be met. It's far too late for token improvements.
Honest Discussion Needed
Not even massive tax hikes can save the system at this point. Businesses and taxpayers would flee. And Illinois is already struggling with corporate and individual flight.
The Illinois pension system is totally broken. It's time to have a truly honest discussion of what to do about it.
Postscript- Illinois Taxes - Loser Spoils
For a look at the Chicago downgrade, please see my post Chicago's Fiscal Freefall: Moody's Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It's All Junk Now.
My first article for IPI was Right-to-Work Sweeps Midwest, Heads for Passage in Wisconsin.
Both articles are up on the Illinois Policy Institute website where you can also learn (assuming you did not know),Illinoisans pay high taxes compared to other Midwest families.
Loser Spoils
Inquiring minds may also be interested to learn via the IPI website, that former governor Quinn Will Receive Millions in Pension Payments
When he ceded his office to Gov. Bruce Rauner on Jan. 13, former Gov. Pat Quinn gave up a $180,000 salary as well.In case you were wondering how Illinois plans became so underfunded, you now have a clear picture: in general, promising far more than can possibly be delivered.
But that same day marked the beginning of a lucrative consolation prize: monthly pension checks that will add up to $137,000 in Quinn’s first year of retirement, according to WUIS 91.9. The former governor will receive $3 million in pension payments over his lifetime should the Illinois Supreme Court strike down Senate Bill 1, a pension-reform law passed in 2013. Should it be upheld, Quinn would still receive over $2 million.
Over his public tenure, which included stints as the state treasurer and lieutenant governor, Quinn contributed a mere $190,000 toward his pension as of November 2014, according to the Chicago Sun-Times. This contribution is not sufficient to cover even the first 18 months of benefits he will collect.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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