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Pension funds with unfunded liabilities - you gotta be kidding


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The unfunded liability issue is fascinating to me and I have a somewhat parallel political analogy to it: In the early 1970s in my province of Alberta, Canada a highly intelligent, forward thinking, Harvard educated Peter Lougheed and his Progressive Conservatives had swept into power and created the "Heritage Savings Trust Fund" (HSTF) to bank billions upon billions of dollars of royalties on the depleting provincially owned oil.  It was a fund for the future - for rainy days - for when selling high margin oil is no longer an option. Well, that didn't last long and the contributions were soon capped by following leaders and the fund has barely grown over the last few decades.  Humorously, in the '80s era of low oil prices and provincial recession, bumper stickers on cars read: "Please God let there be another oil boom and this time we won't piss it all away." Then in the 2000's, God answered our prayers and we had that new oil boom and so - we "pissed" it all away - again.


So now to pensions, a system set up to handle what are essentially royalties on our depleting ability to work, to earn money from our labours. Just as our ability to sell our higher margin oil here in Alberta will come to an end, our ability to sell our higher margin labour will eventually come to an end. So, both individuals and pension administrators require some long-term, actuarial thinking to anticipate future needs. Most individuals can't do it well so experts are hired and paid extremely well to do it for us as pension administrators.


Well, well, well... here we are with record low interest rates which have handed pension funds an unbelievable, "once in a lifetime" (if not two), return on their bond allocations.  We've also seen an amazing recovery since 2008 on equity allocations.  In fact, compared to portfolio return expectations up to the 1980s, I imagine both bond and equity returns have been unexpectedly generous. So to read that many pensions, with their long time horizons, have unfunded liabilities is VERY interesting if not very astounding. 



So if the unfunded liabilities are not portfolio returns what are they from?  In my part of the world pensions are generally blaming unfunded liabilities on increased longevity and baby boomers. Yet, I've heard of the baby boom issue all my life - since I was a kid.  In fact I once Googled baby boomers and pensions and recall finding news articles dating back to the early 1970s raising the issue of the future impact of the baby boomers on social security. In the early 80s in my university courses  the baby boom generation was textbook material.  As for increased longevity, I can't believe that that hasn't also been expected for a few generations as well.  So there should have been no surprises on these two fronts.


So, folks, if the problem isn't returns and it's not liability forecasting, what is it?  What's wrong with the pension system to allow unfunded liability crises to develop?  I would say it's a fundamental problem with those managing they system simply not doing their job, not doing what at the most basic level what they are paid to do.


By the way, back to my analogy: Here in Alberta in the recent election, the electorate ignored the popular right leaning Wild Rose Party, and after an amazing 43 years of conservative rule under the Progressive Conservative Party, the electorate "fired" the incumbents en mass, and swept left leaning NDP party to power with a huge majority.  Of course, this has all happened after oil prices collapsed and it's pretty much too late to save oil royalties for a rainy day and so we all now face austerity measures due to deficit spending and debt levels, no matter who is in power.  That's what's wrong with democracy, we don't elect to avoid obvious pending failure, we penalize after failure.  I imagine a lot of those running pensions today are counting on that fact of life to protect them from their own incompetence*.





I can find articles like this (see below) going back years and years. In the 1970s Buffett was writing about pension problems!  Now the problems are coming home to roost. I believe it was Peterson, before the Peterson Foundation, was saying around the year 2015 the US's social security issue would turn real and involve real money.


Which Cities Should Be Most Worried About Pension Funds?



America’s pension debt problem is at a critical juncture; the Census of Governments reports that pensions now exceed outstanding debt as the largest type of state and local government liability. Next City’s Forefront this week dives into how American cities and states are confronting the snowballing problems of keeping their pension plans funded for the next generations of retirees. ..."







* and those fearing socialist rule as a knee jerk, self-defense reaction to incompetence and dogma, should read about the history of social welfare Otto von Bismarck, Winston Churchill and Lloyd George and how they promoted social welfare to fend off socialism.  Warren Buffett seems to get it too as evidenced by his latest anti-minimum wage but guaranteed gov't paid income suggestion.









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Could allowing liabilities to go unfunded be though of as an alternative to issuing debt? With interest rates this low, it's been a prime time to issue debt. But perhaps the friction from underwriting fees could be eliminated by allowing some other liabilities for which the funding would have went to to grow instead. As for existing portfolios of bonds getting a one time windfall capital gains due to falling interest rates, how much of it is really meaningful and how much of that is being held to maturity?

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I think most failures of democracy come from the bad state of our education system (in almost every western country). The way things are taught is completely wrong. The way economics is taught is dry and way too boring. For some reason when it comes to education, everything has to be boring and dry. Luckily the internet is slowly changing that, but our education system is lagging way behind because of all the bureacrats and unions, and the fact that it is basically a government monopoly.


If most people were taught to think effectively in high school, most of these problems would not exist today. That is why democracies completely fail if most of the population consists of illiterate peasants (to give some extreme example). Just look at various Asian and South American countries.


I like how Asimov explains it (that guy is quickly becoming one of my favourite people):

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Regarding bonds - yes, probably some will be held to maturity. 


When I was young I thought it made sense to own a balanced mutual fund. However, when the market dropped I found that the fund managers just rode out the volatility. I thought, well, I could do that - without paying a premium MER for a never changing asset allocation.  So, would you pay a pension fund manager a premium salary to buy bonds and hold them to maturity despite record low interest rates?  To essentially ignore valuations while possibly taking performance bonuses or at least not getting fired because they are matching their policy benchmarks?


Moreover, at this time they are sitting on unfunded liabilities, so if interest rates rise to more historical levels, what will happen to their liability numbers? 

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Guest longinvestor



Nine of the largest U.S. companies turned $30.61 billion in actual pension fund losses in 2002 into pretax earnings of $7.9 billion, federal filings show.


General Electric, the world's second-largest company by market value after Microsoft Corp., followed accounting rules in reporting positive pension earnings. It used an expected rate of return -- an estimated gain of 8.5 percent -- on its income statement, rather than the actual return, which was a loss of 11.67 percent. The pension investment loss for 2002 wasn't disclosed in General Electric's 26-page management discussion and analysis section. It appeared in a financial footnote in a different part of the report. That type of disclosure is allowed under accounting rules.

Verizon, which said in a footnote that it lost $4.68 billion, reported a $2.5 billion pension gain. That accounted for 40 percent of its 2002 pretax earnings.


Buffett wrote a number of pieces like this during the go-go 1990 years. These are the darlings of the corporate world kicking the can down the road. The road has ended and here we are.

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Its always popular to elect somebody to rob Peter to pay Paul.


Instant Gratification is v popular w/the masses.


I also think it's a matter of simply wanting someone else to bear the cost. It's pretty common knowledge in the United States that the government budget is, and has been, ridiculous for decades. Most people would agree that running consistent defacits is bad and most would agree that we should cut the debt.


But this is where it gets tricky - you could cut 100% of "discretionary" spending and still be running a deficit. People agree that we should balance the budget, but nobody wants their social security check cut, their pension benefits reduced, military spending wound down, less funding for schools, etc. etc. etc. Everyone agrees that there should be cuts as long as you don't cut what is important to them...so nothing gets cut.


Same parallel in Congress - everyone agrees that Congress is embarrassingly ineffective and needs change, but the same people keep getting re-elected because everyone is happy with their individual congressman.


The problem seems to be that everyone realizes that change needs to be made, but are unwilling to accept any changes themselves. They're expecting someone else to bear the burden.


In the case of pensions, nobody is going to forego the "now" for the the "later" because they're expecting whoever comes after them to be the ones to bear that burden.


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But this is where it gets tricky - you could cut 100% of "discretionary" spending and still be running a deficit. People agree that we should balance the budget, but nobody wants their social security check cut, their pension benefits reduced, military spending wound down, less funding for schools, etc. etc. etc. Everyone agrees that there should be cuts as long as you don't cut what is important to them...so nothing gets cut.


There's that other option that seems to be implicitly taken during inaction. Let the dollar gradually devalue via inflation so that everyone can continue to receive their nominal payments. Paid for by the dilution of buying power from anyone making an effort to save money.

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Perhaps the problem is that with record low interest rates, the pension managers are forecasting much lower returns on the pension funds in the future which has given rise to these 'unfunded' liabilities. They may hold lots of bonds that have risen in value nicely over the years, but given that most pension funds will invest for the long term, this increase in 'value' wont actually benefit them much. If they buy a $100 bond with a 5% coupon and maturing in 10 years, does it really benefit them if after 5 years that bond is worth $130 marked to market? They will still hold it until maturity and get back their $100. Only then if interest rates are still low they can only buy a $100 with a $3 coupon. That has implications on them meeting their long term obligations.

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