Pandemic of pension woes is plaguing the nation (CNBC)

[pb4uski]

.....I did not look up performance of Wellesley or Wellington, or Dodge & Cox Balanced which is another good fund that I have. If you said that these return better than the 5.6% that the 100 largest pensions obtained, yes, that could be very well true. What does that prove? .....

Well it proves to me that any claim that part of the reasons why pension funds are in trouble is due to "investment losses inflicted by the 2008 market collapse" is a red-herring because the "market" has fully recovered and then some. The same line of thought would apply where the press or people who claim that individuals can't retire because of the great recession - it may be true but it was because they didn't stay the course and probably bailed on stocks and never got back in to see the recovery. I know many people in this situation.

I suspect that the 5.6% might be about right depending on the average AA of pension funds which may be less equity focused than Wellesley.

Also, I seem to have vague recollection that some pension funds were branching out into private equity and some more exotic investments and I suspect that the didn't understand the additional risks they were taking and got caught by the short hairs.

 

[NW-Bound]

But, but, but you did not think of the 6% WR!

Yes, no doubt some pension funds might have taken additional risks, and got hurt even worse. But let's take the average return of stocks and bonds, and use that as the rule.

As I said repeatedly, FIRECalc and the other historical simulation show that an indexed portfolio got decimated in the last 10 to 13 years, with a WR of 6% or higher. And that's for the entire spectrum of indexed portfolios, from 100% stock to 100% bond.

Have you made a run and see for yourself? Be sure to use 6% or 7% WR.

Wellington, Wellesley, and Dodge & Cox are active funds! God forbid, but they picked stocks!

They did better than the average, which means there are others that are worse than average. And the average already sucked in the recent years.

PS. Please see my post on another thread regarding Wellington: http://www.early-retirement.org/for...loses-to-new-investors-67805.html#post1345708

 

[pb4uski]

Let me frame the issue the other way. Do you think that the 2008 market collapse is a significant cause for the current underfunding of pension plans today?

BTW, the 6% WR is likely predicated on returns over a much longer time frame than the last 10 years.

You also indicate that "an indexed portfolio got decimated in the last 10 to 13 years". At least for the 10 years that is not the case as indexed equities (using Total Stock as a proxy) returned 8.4% and bonds (using Total Bond as a proxy) returned 4.9%. If that is decimated then bring it on as the 7% return for a 60/40 retirement portfolio is 1.5% better than the conservative 5.5% I use for my retirement planning.

 

[NW-Bound]

Since we are both citing actual returns, let's examine and compare them.

At the depth of the recession the $10,000 invested on 8/1/03 had declined to $8,591 and $11,459 for Total Stock and Wellington, respectively, but the most current values are $22,363 and $23,198, respectively for IRRs for the 10 year period of 8.4% and 8.8%, respectively.

Wellesley had a flatter line and dipped to $11,478 in 2008 but still returned 7.4% for the 10 year period.

There, you are using the starting point as 2003, near the bottom of the market in that period. And then, you are using the end point of the current date of 8/2013, which is currently at an all-time high. Of course the result will look better.

On top of that, the numbers are before inflation. So, you need to adjust for that. Additionally, the returns are for 0%WR. Let's put a 6%+ WR that the pension managers had to pay and see how that looks. You would have drawn down your principal such that when the market recovers, you had nothing left to gain from the rise.

You wrote "BTW, the 6% WR is likely predicated on returns over a much longer time frame than the last 10 years."

Of course I agree with that. Now, the recent lousy performance has caused the fund assets to drop, exactly like the FIRECalc traces that drop and skim the bottom of the chart for bad periods.

We have been talking about if one retires in a good year and bases his 3.5%WR on that year, it's not going to be the same as retiring in a bad year and basing the 3.5% on that bad year. During the good years of 1980-2000, perhaps many pensions did build a surplus. People probably demanded a cut-back in contributions, or an increase in benefits, or both. And the market performance allowed them to plan on a higher WR. In about 2001, I read an article in Business Week saying that some pension funds projected a return of 9%. BW said that was too high and suggested 7 or 8%. Even that turned out to be too high.

Now, what do we do? Should the pension managers cross their fingers and hope for a string of good years to bring their assets up? Or do they have a choice of cutting down WR like some concurrent threads talk about going even below 3.5% WR (from the current 6%+) to regain after a string of bad years? Or bring in new contributions? The latter means going back to work for ER people, and raising taxes for state pensions.

The above quandary is what we talk about here.

PS. Also remember the additional problems that Mulligan talked about, namely retirees living longer, while the current contributors drop in numbers due to cut-back of state employees. Tough, tough problem!

 

[Chuckanut]

Politics is another reason some pensions are in trouble. Politicians put pressure on state pension managers to fund, guarantee and invest in pet projects. Here is a good example:

Michigan movie studio defaults on bond payment, state pension funds to cover costs | Michigan Radio

 

[clifp]

While investment returns are certainly a factor I think there is a lot else going on that is making the pension funds look worse.

Very slow growth in both public sector employment and wages, now in the long term this is a good thing. But in the next 20-30 year this a bad thing since less workers to pay into the fund making lower salaries hurts the ability to pay current and worker near retirement.

Lower than expected number of folks quitting public sector jobs before vesting. This clearly a function of the crisis.

Systemic underpricing of everything from early retirement, to purchasing of service credits.

Lots of people gaming this system. Now I don't have any hard data on this, but this includes various pension spiking tricks, which are only now being plugged. Plus legitimate things like people taking public service jobs in their late 40 or early 50s working 10 to 15 years to get the good pension plus medical care. I have yet to see a pension plan detailed report that models this correctly.

For the badly underfunded plans like Il. or right here in Hawaii. A huge factor is the state government not contributing what they needed to.

Finally, while pb4uski is right 7% is a perfectly respectable return before the crisis the typical pension plan was estimating 8.5-9% returns. The 1.5-2.0% shortfall over ten years adds up to 15-20% shortfall.

 

[NW-Bound]

Lest other posters get me wrong, I am not saying that many (most?) pensions have not been mismanaged, or that demographic trends did not play a part, or there have not been abuses etc...

My point in all earlier posts was that my simple simulation runs show that just the poor market performance would have done them in already with a 6+% WR. Or are we saying now that FIRECalc and other historical simulations are just garbage? Shall we have WellesleyCalc or WellingtonCalc for ER planning?

My own lesson from this: Stick with 3.5% WR, or I may go down the tube. Well, I might not either, as I may not live till 80.

And then, remember that if your portfolio goes down 50% (after inflation adjustment, mind you) like bad years in the historical simulation (with just 4% WR too!), you know and accept it. But with a public pension, they will want your head! You will get nailed to the cross for being 50% underfunded.

 

[ERD50]

Lest other posters get me wrong, ....

And then, remember that if your portfolio goes down 50% (after inflation adjustment, mind you) like bad years in the historical simulation (with just 4% WR too!), you know and accept it. But with a public pension, they will want your head! You will get nailed to the cross for being 50% underfunded.

OK, I did sort of miss where you were going, but it is clear to me now.

And a portfolio/fund can go down ~ 1/2 even with no withdrawals! 6% versus 4% probably won't make all that much difference, but it sure won't help.

One advantage the pension funds have over the individual retiree - they truly can pool that longevity risk. Look at all the threads here asking about how long you expect to live. People like me want to plan for the best (worst?) case, and that means cutting the WR some. But the pensions just look at averages and have at it - (almost) no worries!

-ERD50

 

[NW-Bound]

Yes, it is true that a portfolio can go down 50% whether the WR is 4% or 6%. The difference is that one has a much better chance of recovering with 4% than with 6%. But meanwhile, it is scary for an individual and causes mass hysteria for a public pension.

And I just found out that CalPERS, a very large fund was still expecting 7.5% return! Moody said only 5.5% could be expected, looking forward. Whether these numbers are before or after inflation, I could not find out.

About longevity pooling, a pension may be able to pay an individual higher than that person can get himself. But the aggregate payout cannot be larger than the fund return, correct?

By the way, I found the following excerpt from an April 2013 article on the return of CalPERS, one of the largest pensions. Note that CalPERS lost only 1/3 at the bottom of the Great Recession, about the same or possibly less than Wellesley, Wellington et al. And if you are going to say Wellesley and Wellington have rebounded sooner, remember to compare their performance under 6%+ WR.

The California Public Employees’ Retirement System reached a market value of $260.8 billion in assets, surpassing the high set before the global financial crisis wiped out more than a third of its wealth.
...
The largest U.S. pension, with half of its money in equities, passed its pre-recession high of $260.6 billion on Oct. 31, 2007, according to a posting today on its website. The fund returned 13 percent in 2012, about the same gain as the Standard & Poor’s 500-stock index.
...
Even with its gains, the Sacramento-based pension is still short $87 billion, or about 26 percent, of meeting its long-term commitments, and has had to ask the state and struggling cities to contribute more.​

 

[pb4uski]

....And I just found out that CalPERS, a very large fund was still expecting 7.5% return! Moody said only 5.5% could be expected, looking forward. Whether these numbers are before or after inflation, I could not find out......

You're kidding, right? Those have to be nominal returns, not real returns.

Is the 6% WR you seem so focused on net of contributions, or excluding contributions? What was the source of the 6% WR?

 

[NW-Bound]

You're kidding, right? Those have to be nominal returns, not real returns.

Eh, like I said, I did not know, and I just could not be sure of anything. I saw something about a CalPERS manager saying the stock return of the last 30 years was 11% (nominal), so why he couldn't expect some reversion to that, or something like that.

People tend to mix up nominal vs. real return, so I do not want to assume anything, and I stated so. Hopefully, they meant a nominal return of 7.5% and not real.

But what is the YTD return so far in 2013? Happy days are here, oui?

Is the 6% WR you seem so focused on net of contributions, or excluding contributions? What was the source of the 6% WR?

I mentioned reading an article in BW in 2001 saying pension funds were expecting 9% returns. And if we take that as nominal return to be safe, and assume a 3% historical inflation, then the expected real return is 6%. So, I assumed that the pensions were going to spend that. I will admit that I forgot about contributions. That would mean they could spend even more!

You want actual numbers? Man, you make me work too hard!

But I wanted to satisfy my own curiosity too. Thanks goodness, a quick search found on Wikipedia the following. See CalPERS.

The California Public Employees' Retirement System (CalPERS) is an agency in the California executive branch that "manages pension and health benefits for more than 1.6 million California public employees, retirees, and their families". In fiscal year 2007-2008, $10.88 billion was paid in retirement benefits, and in calendar year 2009 it is estimated that over $5.7 billion will be paid in health benefits.

... the peak value of its assets of $260.6 billion in October 2007...
​

I do not know if administrative costs were included, but that was a payout of 6.4%. From that, we need to subtract contributions, so the outflow was certainly less than 6%. But we also need to consider that the balance in Oct 2007 was an all-time high too.

That's as far as I got. So, take a WR of 5% or whatever, then run FIRECalc over the recent years, and perhaps we'll see that it still would not look too good.

 

[ejman]

As I described in another thread, the market performance in the last decade has been dismal. Here's the result from a historical simulation that I found online for 3 different portfolios over the period of 1/2000 to 1/2013. The results are annualized and corrected for inflation.

100% stock: -0.5%/yr (Note: Annualized total return, inflation-adjusted)
50/50 stock/bond: 0.97%/yr
100% bond: 1.49%/yr

It should be no wonder that so many institutional investors ran into trouble. I am sure they used much higher return numbers in their projection.

So, unless they were good stock pickers or good market timers, they were doomed. If you are average, you are dead meat. And of course, not everybody can be above average.

Well, I owned both Wellesley and Wellington during the period in question and IF Quicken is to be trusted, a combination of those two delivered a not too bad 7% rate of return annually from 1/1/2000 to 1/1/2013 (not inflation adjusted). Maybe those pension managers ought to listen to Uncle Mick?

 

[NW-Bound]

But as I pointed out, these funds are active funds. What if the entire US buys into these funds? Would that mean that 100% of people would be better than the average?

Isn't there a concurrent thread about Wellington closing to new investors? CalPERS itself is 3.5 times the size of Wellington, let alone other pension funds.

 

[pb4uski]

You're not even close. But let's not let facts derail a good debate.

$ billions	2012	2011
Benefits	16.0	14.8
Contributions	11.4	11.0
Net	4.6	3.8
BOY balance	241.8	201.6
WR	1.9%	1.9%

See http://www.calpers.ca.gov/eip-docs/about/pubs/2012-executive-summary.pdf for details

 

[NW-Bound]

From your source, I saw the contribution of $3.6B employee + $7.8B employer = $11.4B. Checked. That's what I could not find.

However, the benefits were $15.4B retirement + $6.9B health benefits = $22.3B.

That works out to 4.5% WR. Not as bad as I thought, but more than you computed.

If it were really 1.9% WR, why would they be in trouble? Is that not we were talking about?

 

[pb4uski]

From your source, I saw the contribution of $3.6B employee + $7.8B employer = $11.4B. Checked. That's what I could not find.

However, the benefits were $15.4B retirement + $6.9B health benefits = $22.3B.

That works out to 4.5% WR. Not as bad as I thought, but more than you computed.

The $6.9b for health is premiums (not benefits) and is separate from the pension plan. The numbers on page 3 are complete and roll forward from year to year. The numbers I showed all came from page 3.

 

[NW-Bound]

I will admit I do not understand any of this accounting. A portfolio running into short fall for spending 1.9%? How am I going to survive with 3.5%?

Please explain. I am seriously worried.

 

[pb4uski]

What is the basis for your conclusion that the plan is in trouble?

 

[NW-Bound]

Let me google that for you: CalPERS Pension Fund Underfunded

 

[ejman]

But as I pointed out, these funds are active funds. What if the entire US buys into these funds? Would that mean that 100% of people would be better than the average?

Isn't there a concurrent thread about Wellington closing to new investors? CalPERS itself is 3.5 times the size of Wellington, let alone other pension funds.

As that feller from Minnesota pointed out, it's entirely possible for everybody to be above average

 

[NW-Bound]

Well, many posters here weren't sure of that. So, they flocked to get in before these funds close. Have you seen those posts?

I don't know. I really wonder now.

You see, I had Dodge & Cox Balanced Fund for a long time. I tried to sell my friends on that, but they thought it was too stodgy, not fast climbing as they wanted. Then, the fund closed, and I felt so smug.

It kept climbing until the Great Recession, and crashed hard because of heavy overweighting in financial stocks. Man, I was hurting. But I did not sell, and the fund has rebounded.

By the way, the fund reopened while it was tumbling down. I guess the fund manager wanted to get some fresh money to replace the redemption.


PS. The last 12 months, DODBX trounced Wellington, let alone Wellesley. So, I was curious and looked to see what they were doing. While people were still hanging on to their bonds, afraid to let go, these guys were shorting the 10-year Treasury.

Could you believe that? Gutsy! Whoo Wee! I am just going along for the ride.

PPS. DODBX (Balanced Fund) is more the more conservative fund of Dodge & Cox. Their more gung ho fund is DODGX, which I do not have. Check that out! The animal spirit is back!

 

[NW-Bound]

Sorry for going off-topic, but I just looked and compared Wellington/Wellesley to Vanguard S&P 500 Index (VFINX), because of ejman's previous post.

What I saw was that most of the lead of Wellington and Wellesley over the period of 2000-2013 happened during the 2000-2003 period. That was because their managers sidestepped the tech stocks that crashed hard back in 2003. These stocks and some dubious dotcoms were a big part of S&P back in 2000.

For the period of 2003-2013, Wellesley is about the same as the S&P 500, while Wellington is a bit better. So, when you get in makes all the difference.

 

[NW-Bound]

OK. I have done a bit more searching on the Web, and have learned a bit more about CalPERS.

Sorry that I was such an ignoramus to compare the operation of a pension fund to that of a single person's retirement fund, namely for myself.

The answer can be found here: http://www.calpers.ca.gov/eip-docs/about/pubs/cafr-2012.pdf.

Basically, the fund's current expense, after subtracting contributions, is indeed 1.9% as pb4uski stated. So, why the problem?

What happens is that when they project the growth of the liabilities, namely future expenses to be paid or promised to retirees, they will run short. They are not short now.

The projection of future expenses is based on actuarial valuations, using retirees' expected life spans, promised benefits, etc...

But since the current expense is only 1.9%, which is very low, what are the expected investment return and inflation? CalPERS uses an expected nominal return of 7.5%, and an expected inflation of 2.75%.

The above means CalPERS expects its fund to grow at the current rate of 7.5%-2.75%-1.9% = 2.85%. For an individual, if I just want my stash to keep up with inflation, then I can spend 7.5%-2.75% = 4.75%. Heck, that's a lot better than my planned 3.5%. I wish!

Obviously, they expect that the expense will grow beyond 1.9%, in fact beyond 4.75%, and they will be in trouble in 30 years. They project a short fall of $87B on top of the current asset of $247B, looking 30 years ahead.

Wow! I have learned a lot. That is, a pension that currently spends only 1.9% will still be in trouble, because of its future liabilities that keep on growing. For a single retiree, he would be happy just to maintain the same expense with inflation adjustment.

In summary, the fund is not in shortfall now, but will be, based on actuarial projections.

So, what kind of promises have been made? Obviously lots of gravy!

 

[pb4uski]

You're doomed NWB! Time to look for a job.

You're still being way to simple about it and it doesn't make sense to try to analogize a pension fund to an individual's retirement fund - unfortunately, its a lot more complicated than that. A pension fund continually has inflows (contributions) and outflows (benefits paid) whereas an individual retirement fund only has outflows (living expenses) because there is no savings.

Page 128 shows the history of the funding status. The main plan has actuarial funding gradually declining from 87% in 2003 to 83% in 2011. The funded status based on asset market value, which is a better measure, grew from 2002 to 2007 when it exceeded 100% and then declined to 61% in 2009 and then has increased to 74% in 2011. Given the rally since mid 2011 to now, I suspect that funded status is significantly better today than it was back in 2011. Remember, anyting over 80% is pretty good.

I didn't find the sources you provided suggesting that the plan is in trouble to be very credible. Any moron can write a blog and have an opinion.

 

[ziggy29]

Much of the problem is that when the markets were rising, states weren't putting in the full amount they should have been contributing, arguing that market gains allowed their fund to remain above some threshold that keeps it viable. The problem is, that assumes the gravy train keeps on rolling, because if it doesn't, you may have to "double down" and put in even more in a market downturn. And since those often correspond with recessions, a state is faced with contributing more at a time when it can least afford it (tax revenues down, need for social services is up).