Who’s the Shiftless Brother-in-law Here?

Politicians are willfully ignorant and actuarial opinions can be bought.

This should be the starting point for every discussion of the public pension crisis in the United States.  It’s not in the recently released Blinken Report and, as useful as the report might be for providing some general background, its misguided emphasis on a risk-free rate of return for valuing liabilities dooms it to irrelevancy.  Boyd and Kiernan on page 3 argue:

Amounts that are extremely likely to be paid will have lower risk, and therefore a lower discount rate, than amounts that are less likely to be paid— just as lenders charge more to risky borrowers than to creditworthy ones. And the higher the discount rate, the lower the estimated liability. If the government has a firm commitment to pay you $1,000 in fifteen years, you will use a lower discount rate to determine the value of that promise today than if your shiftless brother-in-law promises to pay you the same amount. The former, if discounted at a 3 percent rate, would be worth about $642 today, while the latter,  discounted at 8 percent, would be worth about $315— less than half as much. This makes sense — if you could sell the right to receive these payments, purchasers would gladly pay more for the right to receive a guaranteed payment from the government than to receive an uncertain payment from your brother-in-law.

But when it comes to public pensions who is really the shiftless brother-in-law?

Prichard, AL and Central Falls, RI have already defaulted on pension payments to retirees and Detroit is about to.  Ten states have reduced or eliminated promised cost-of-living-adjustments on pensions.

The risk-free argument basically justifies governments using an 8% (or 15%) rate of return since the chances that full benefits will be made to all public employees is minuscule.  The only issues are which group gets defaulted on, how much, and when.

I understand the authors (and I) would prefer to see these liabilities being valued honestly but that will not happen and would serve no purpose.

It won’t happen for the reasons mentioned up top.  Politicians are innumerate and only interested in meeting short-term objectives even if they have to be creatively lied to about methods and actuaries are all too willing to do that creative lying.

And even if we had contributions determined using honest assumptions assuming all benefits promised would be paid then what reaction could we expect from Chris Christie were he presented with a pension bill of $10 billion instead of the $2.4 billion he expected (and is trying to weasel out of as I type)?

10 responses to this post.

  1. Posted by Tough Love on January 26, 2014 at 2:03 am

    Quoting…”The risk-free argument basically justifies governments using an 8% (or 15%) rate of return since the chances that full benefits will be made to all public employees is minuscule. The only issues are which group gets defaulted on, how much, and when.”

    John, that’s an interesting point for the Plans (many more than just the ones we regularly hear about) in distress, but it doesn’t hold water for the few (or more than just a few perhaps) in reasonably good shape …. which continue to use unreasonably high discount rates.

    Nor does it address the fact that since these Plans’ infancy, they have ALWAYS used the assumed return on investments for discounting Plan liabilities … thereby that practice being the CAUSE of this mess in the first place.

    —————————————

    That being said, THIS quote of yours:

    “I understand the authors (and I) would prefer to see these liabilities being valued honestly but that will not happen and would serve no purpose.”

    is very likely correct but only because our self-serving elected officials unfortunately let this get past the tipping point where a solution was possible.

    Nothing will happen because the “cost” of fixing it now is just too great, either:
    (a) monetarily by either Tax increases or worker contribution increases, or
    (b) by the workers agreeing to the huge pension cuts that would be necessary.

    Reply

  2. […] « Who’s the Shiftless Brother-in-law Here? […]

    Reply

  3. Posted by MJ on January 26, 2014 at 5:42 pm

    Are the Detroit pensioners getting hair cuts? Seems like their pensions won’t be getting cut as much as previously thought which begs the question, where will the money come from? With all due respect to Mr. Bury, why do you seem to be the only one exposing this assuming what you report is true. It seems to me, that the pensions are getting paid now and will continue for years to come. As you stated in your previous UC blog, politicians answer to no one so why bother changing anything. Are current retirees still receiving free life time health benefits? Is the plan to move them all onto Obamacare? It doesn’t add up.

    Reply

    • Posted by Tough Love on January 26, 2014 at 7:20 pm

      The “nothing will happen” (i.e.,cuts in pensions & healthcare promises) certainly doesn’t apply to Detroit.

      In this case, the money (even NOW) doesn’t exist. Delay only work while there is still some money in the till.

      Short of the Feds doing something (money, loan guarantees,etc.), Detroit has no options … except material reductions.

      Reply

      • I agree and the reason is that Detroit has made it abundantly clear that funding past promises is not an option as their blueprint for survival seems to be to attract people and businesses by spending more borrowed money. Repaying past debts is not a priority and nobody is going to lend Detroit any money if there’s a chance it will go to pensioners thus increasing the probably that these new loans will default.

        Reply

  4. Posted by Anonymous on January 27, 2014 at 10:52 am

    Will the Feds bail them out?

    Reply

    • Posted by Tough Love on January 28, 2014 at 12:41 am

      It would set a very bad precedent. Why should states (and cities) that have acted responsibly (meaning NOT granting unaffordable OR greater-than-necessary pension & benefits) be made to subsidize those that have acted irresponsibly?

      And please, spare me the workers moans that they regularly paid their “share” …………….. their “share” of a HUGE/unnecessary/unaffordable promise being PEANUTS..

      Reply

  5. Posted by MJ on January 28, 2014 at 7:09 am

    If the DB plans are bankrupting cities and towns across the country why is Detroit still keeping DB pension plans? Seems like no one wants to change despite all of these problems?

    Reply

  6. Posted by LGreene on March 16, 2014 at 6:47 am

    Too much of this debate seems to revolve around political and philosophical agendas. ALL DB plans can’t be bankrupting cities and states. Even in Detroit, they are coming up with a plan to get new monies ( foundations and state funds) into the pension system. Some pension practices are being reviewed and revised ( COLA, 13th check, DROP , modified multipliers_

    Instead of demonizing public workers and retirees ( most of whom are over 50) I wonder if there are those in this educated group that could propose :

    1) A reasonable DB plan structure that doesn’t include the over promises that some claim here, and

    2) What ( if any) NON-Taxpayer sources can be developed and introduced to help fund these plans ( like the foundation/state contributions being proposed in Detroit).

    3) If a city does go bankrupt, what would a fair plan/haircut be that doesn’t overly burden the oldest retirees nor the ones that receive the smallest distributions? 34% across the board seems excessive for those that receive $15,000-40,000 per year.

    Reply

  7. . Some in the writers have specialized in nursing, education and law.

    Reply

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