Pensions – Don’t Panic!

Timothy Alexander’s first blog here elicited 80 comments. Here is his second and the start of a series:

This is my second publication and I am very grateful for this opportunity.  When I have fear it often begins with ignorance of an issue.  My fear may grow into stasis; not knowing what to do or where to turn and inaction just make things worse.

I offer a few short important words: enlightenment, empowering, and energized-actions; summarized in Don’t Panic!  There are many terrified, intelligent people not comprehending what is happening to their pensions.  Not everyone has the financial skills to understand the crisis.  So let’s start with education or enlightenment.

Interest rates are a primary key in most financial discussions.

Suppose a man needs a $1,000,000 mortgage and the simple interest rate is ten percent.  His annual interest payment is $1,000,000 times ten percent or $100,000.  Now suppose over a short period of time the rate falls to five percent.  His annual interest payment falls by half to $1,000,000 times five percent, or $50,000.  For the homeowner this is great.  But what about the bank?

The bank was making $100,000 per year income and then income was cut in half.  The bank, as a business, must pay salaries, leases, utilities, etc.  To compensate a bank must make and manage more loans and get back to the status quo income level.  What employee likes to be told; “work twice as hard (or more) and hope your pay remains the same!”

Now consider a simplified pension.  Suppose a man works from 25 until 65, retires with a possible 15-year retirement lifespan hoping for 80% of his salary or $40,000 per year.  Assume a $50,000 salary and no raises (a very simple model).  The employer and he both contribute $200 per month, $400 total or $4,800 per year.  The total value of his pension payments are $192,000.  Assume there was no investment and the money went “under a mattress”; will he have enough money for a 15-year retirement?  Divide his $192,000 retirement balance by his desired $40,000 and he will have enough money for under five years.  This is far short of the desired 15-year life span; a dismal outlook.

He must invest his pension payments and earn a return.  If he wants $40,000 per year and the expected lifespan is 15 years the retirement fund would need $40,000 times 15 years, or $600,000.  He is underfunded by $408,000 as his fund balance is $192,000.  This shows why interest rates are so important.

There is a financial concept called “future value”.  We can compute the future value of a fund assuming an average rate of return.  Suppose the retirement payments went into a bank savings account at an average two percent interest rate over the 40 years. The fund balance at retirement would be about $290,000. Divide $290,000 by $40,000 per year and there is funding for seven and a quarter years.  Still very short of the desired 15 years.  An average return of about five and a quarter percent would be worth about $616,000, or fund about 15. 4 years.  Many actuaries report public pensions need a rate of about seven and a half percent, suggesting a future value of about $1,091,000 funding about 27.3 years in our example.  But are these actuarially ideal target rates being  achieved?

Consider the 2016 CALSTRS annual report from page 7:

The increase in the actuarial obligation due to the new assumptions and the less-than-assumed return (Milliman estimate of 1.3% compared to the prior valuation assumption of 7.5%) in the most recent year were the most significant factor s decreasing the Funded Ratio.

Suppose missing the projected rate of return by 6.2% translates into a loss to the fund of $12.7 billion dollars.  What happens if the investment gap is two or more years?  The report shows in 2016 that members and employers increased contributions by 37%, or $732 million dollars.  Will California teachers and other pensioners realize this problem cannot be resolved by tossing a penny back in while the fund is bleeding dollars?  There is no amount of negotiation that can come close to solving this problem.

In response to my first publication commenters adamantly banged their first and shrieked: “This pension is best and the rest is robbery!” Other commenters are equally defiant on different structures.  Omitted is the critical commonality – interest rates or rates of return.  Regardless of pension type (public, private, Social Security, 401K, etc.) all need a minimum rate of return.  If any type of pension fails to make the minimum rate of return with safe investments the pension goes bust.  It is just that simple.

If any reader is scared please reach out to me.  Next will be Empowerment!

Timothy Alexander

Managing Director

22 responses to this post.

  1. Posted by dentss dunnigan on November 18, 2017 at 5:14 pm

    We’ve had zero interest for 10 years one full decade..look at the balance in the fund and see what annuity you could buy to pay the pension that are owed ….then you’d panic …


  2. 1887 Alexander Tyler, a Scottish history professor at the University of Edinburgh, had this to say about the fall of the Athenian Republic some 2,000 years prior: “A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury.


  3. Posted by Pat W on November 18, 2017 at 5:53 pm

    a RETIRED man who needs a $1,000,000 mortgage? wow. You lost me at “hello”


  4. Move everyone to Social Security Here’s my solution:



  5. Posted by Anonymous on November 18, 2017 at 7:43 pm

    How About – Tax Cut, Panic! Suppose a ‘balanced budget hawk’ proposed, primarily for the rich, a deficit funded tax cut. I’d say that’s worse than someone ‘needing’ a million dollar mortgage…..


  6. Posted by Tough Love on November 18, 2017 at 9:15 pm

    Quoting …… “There is no amount of negotiation that can come close to solving this problem.”

    THAT, I agree with, but not because it inherently CAN’T, but because Unions WON’T. It’s called greed and an extraordinary sense of entitlement.


  7. Posted by Anonymous on November 19, 2017 at 7:40 am

    TB-thank you for sharing on the American Retirement Act. I am always eager to learn. In the process of reading your citation was mention of the United States Census Bureau’s Quarterly Survey of Public Pensions. I found the second quarter fascinating reading and plan to speak with the authors. I am very curious about the rapid growth in international securities by American public pensions, I hope these are not all European Sovereign debt. I equally note the large increase in stocks, by public pensions. I hope the pension investors are that stock markets do have bear moves, and are on the lookout.
    While still digesting your suggested alternative pension plan, are you sure you read point one carefully?
    “Aside from the employee contribution to their pensions, all other monies deposited are
    from taxpayers, and therefore are subject to being repurposed for the benefit of all
    I read this to be the monies deposited by any single employee (you), may be redistributed to any other? Contributions can be used to support anything other than your own retirement. Are you sure you are OK with this?
    One other initial reflection on the ARA. The second page states a consolidation of pensions is a desired goal. It references the public pension assets, which are trillions of dollars. But remember these have unfunded liabilities in the tens of trillions of dollars.
    In the financial world is the concept of leverage-the ratio of debt to equity. It is believed the higher the leverage, the more-risky a company becomes for lending, investment, etc.
    Suppose we create a brand new metric for public pensions. Let’s call it the unfunded leverage, and define it as the ratio of unfunded liability, based on actual, historic returns, to total assets. Please remember, I just made this up. If we consolidated pensions, I would be afraid the consolidation of unfunded portion would be so large, it would become close to an unsolvable riddle.
    I will continue to study your submission, and then you.
    Tim Alexander


  8. Posted by Tim Alexander on November 19, 2017 at 7:57 am

    I am a bit puzzled by the lack of comments on my CALSTRS observations. The fund states necessary returns, as suggested by actuaries, is seven and one half percent, but the fund, for 2016 returned a paltry one and three tenths of a percent. This is about the savings account rate. According to the SECOND QUARTER 2017 Summary of the Quarterly Survey of Public Pensions, CALSTRS may lead in new contributions, but severely lag in other key areas, such as asset growth.
    Suppose that CALSTRS is representative of pensions. I wonder at what point with contributors begin to ask very hard questions, and demand changes in fund management?
    What will it take, I wonder???


  9. Posted by Anonymous on November 19, 2017 at 1:08 pm

    “I am a bit puzzled by the lack of comments on my CALSTRS observations. The fund states necessary returns, as suggested by actuaries, is seven and one half percent, but the fund, for 2016 returned a paltry one and three tenths of a percent.”

    I, too, am puzzled.

    Are you serious?

    In 2016-2017 CalSTRS earned 13.4%. And they lost 25% or more in 2008, 2009, similar to the gains and losses in many other pension plans.

    Perhaps you are in the wrong business…

    “Economics is a social science that studies the management of goods and services, including the production and consumption and the factors affecting them. Finance is the science of managing funds keeping in mind the time, cash at hand and the risk involved. Branches of economics include macro and micro economics.”


  10. Posted by Tim Alexander on November 19, 2017 at 3:23 pm

    Anonymous-If I am misquoting, I apologize and please show me where. Here is a link to the file I reference.

    Click to access cafr2016.pdf

    Page seven states; “This year’s fiscal year’s investment returns of 1.4 percent (net) continued to dip below the actuarially assumed rate of 7.5 percent (net) and emphasize the ongoing importance of implementing risk mitigation strategies within the portfolio.”
    Can you show me where I am misquoting? Is there a different document I should quote or cite?
    Please feel free to call and correct any error I may have made.
    Tim Alexander


  11. Posted by Anonymous on November 19, 2017 at 4:19 pm

    Your quote is impeccable. I just wondered why you focused on one year (actually there were two successive years with below average returns) to suggest that perhaps CalSTRS investment strategy is deficient (or, what are you suggesting?)

    In the same time frame, CalPERS also had low earnings, bracketed by two years of higher than “expected” returns…

    Click to access facts-investment-pension-funding.pdf

    In April, 2015, S&P 500 was over 2,100. By January, 2016, it was down to 1,800.

    To “mis”paraphrase Frank Sinatra, “It was a very bad year”.


  12. Posted by Tim Alexander on November 19, 2017 at 6:49 pm

    Anonymous-Thank you for being an intelligent commenter.
    First, I used CALSTRS as it was easiest to find. I initially tried looking for, but was unable to locate CALPERS, so your assistance is most welcome.
    Second, I would politely disagree with your assessment of either 2015 or 2016 being a “bad year”. Consider the S&P in March of 2009 at about 683. Since then is has almost gone straight up to 2579, for an approximate increase of 278%.
    In January 2015, it started about 2058. By the end of the year it was 2044. This was a very slight pull back, a decrease of about 1%. This could be called flat, not disastrous.
    In 2016, the S&P appears to have grown about 26%. If the S&P set larger rates of returns, the CALPERS average rates of return should be higher and more consistent.
    CALPERS report shows an average net rate of return between 2015 and 2016 of about 1.5%, while the average US GDP was about 3.25%. The average CALPERS return could not even keep up with economic growth; 13% for the S&P between 2015 and 2016
    When I reflect on how many lost money in the last stock market crash, I would be a bit reluctant to have significant holdings in stocks, but that is my opinion.
    Here is the most distressing statement I have read thus far, in the CALPERS materials. CALPERS has only hit the targeted rate of return 18 of the past 24 years, or 64% of the time. How is it possible to have a retirement with such a dreadful record? Also, there is an implication of a single target rate, for almost three decades. If this observation is correct, there are much larger problems.
    2015, 2016, and 2017, collectively, could rather be called the “best of times”. Inflation is low, stock markets are up, unemployment seems down, treasuries are reasonable; not disastrous at all.
    Please feel free to call, and thank you for comments that make me think and research. I need time to study the CALPERS annual statements and understand why the net returns are so volatile under times of consistent, steady, global economic growth.
    Tim Alexander


    • Posted by Anonymous on November 19, 2017 at 7:25 pm

      Possible volatility reasons, among others, divesting in alternative investments as well as internationally, region specific, due to social reasons. Could be someone is either sleeping on the job or on the take…..


    • Posted by Tough Love on November 19, 2017 at 8:48 pm

      Quoting …..

      “Second, I would politely disagree with your assessment of either 2015 or 2016 being a “bad year”. Consider the S&P in March of 2009 at about 683. Since then is has almost gone straight up to 2579, for an approximate increase of 278%.”

      What’s you point, picking a VERY unusual low point followed by a great recovery?

      One could easily go back to an earlier S&P peak of 1520.77 on 9/1/2000, and given that the S&P hit 2579.36 on 11/1/2017 we’ve had a rather lousy compound annual return of just about 3.1% over those 17 years.


    • Posted by Tough Love on November 19, 2017 at 9:34 pm

      Quoting ……….

      “In 2016, the S&P appears to have grown about 26%.”

      S&P on 1/04/16 = 2,012.66

      S&P on 12/30/16 = 2,238.83

      2,238.83 / 2,012.66 = 1.1124 or an increase of 11.24%, not 26%


  13. Posted by Anonymous on November 19, 2017 at 8:06 pm

    See Girard Miller…

    Especially numbers 9 and 10, but the entire article is good.

    I think even a lot of staunch DB pension supporters agree, with 20/20 hindsight, that the discount rate should have been reduced, maybe a dozen years ago, or more, to the 6% +/- range, to keep a funded balance of 100% or more.

    I don’t think most reasonable people fault CalPERS or CalSTRS for poor investment abilities, but for other governance reasons.

    I am by no means an investment expert, and no intention of learning. Our IRAs are in a managed Fidelity fund which happens (we did not request it) to have roughly the same asset mix as CalPERS, and we are quite satisfied.


  14. Posted by Tim Alexander on November 19, 2017 at 10:49 pm

    TL-Thank you for sharing. I prefer to wait for final audited numbers, while you sent over a news release. It is true, the numbers are encouraging, and I hope they hold.
    The CALSTRS 2016 audited annual report was dated 9/30/2016, and I am unable to locate the 2017 audited report. Either I cannot locate or it is delayed, and the possibility of a delay is curious.
    The release you cite states the June 2017 investment fund balance is about $208.7 billion, an increase over 2016 by about $1.16 billion or, 0.6%. If the fund did return 13%, as stated, using an estimated simple interest and the 2016 ending balance, the CALPERS investment fund should have made a minimum of about $26.98 billion. If we subtract the 2017 investment fund net growth of about $1.16 billion, I find about $25 billion I cannot account for, based on your news wire release. I am sure there is a simple and logical explanation.
    I believe it to be foolish in the extreme to begin rejoicing based on a preliminary release. I will look at the audit, when available. But given the massive, unexplained and unaccounted for $25 billion, or so, one should proceed with caution.
    Again, let me say I hope the numbers prove true. I would like very much to study the prior year audited annual reports, from 2010 through 2017, but I can only find 2016, nothing older. Comments in the 2016 CALSTRS audited annual report suggest that very low net investment rates have been the norm for years, add to that an anemic growth in the dollar balance of the investment fund, and I am afraid you are very wrong. I will agree with Stanford; the funds could be looking at up to a 60% unfunded liability.
    You are always welcome to call.
    Tim Alexander


    • Posted by Tough Love on November 20, 2017 at 12:33 am

      Oh don’t get me wrong …………. in my pointing out that 6/30/16 to 6/30/17 turned out to be a very GOOD year of investment returns vs the 6/30/15 to 6/30/16 period that you kept referencing with very POOR investment results……………… I too agree that the TRUE underfunded liabilities for CalPERS, CalSTIRS, and almost all other PUBLIC Sector Plans are MUCH MUCH greater than reported.

      In fact, I believe that notwithstanding complicating Regulations, Laws, Constitutional Issues, Contract Clauses, and Case Law, ANY effective “solution” to the pension mess infecting many of Americas States & Cities MUST include (as just one necessary step) a VERY material (think 50+% in value) reduction in future service accruals for all CURRENT workers.

      Who was that that said …………… the FIRST step in digging yourself out of a deep financial hole, is to STOP digging.


    • Posted by Brian Grinnell on November 20, 2017 at 11:34 am

      You need to consider the source of your asset valuation numbers, and which programs they include – the basic DB plan and/or the 403(b) and 457(b) plans, the health Benefits Fund, the Teaches’ Deferred Compensation Fund, the Supplemental Benefits Maintenance Account, and/or the DB Supplement Program. And then you need to consider whether the returns quoted are on market value or ‘smoothed value’.

      More importantly, and much more simply, you need to consider that the program is not a simple accumulation account and you can’t get the ending balance by multiplying the beginning balance by the return. There are ongoing contributions and benefits. In 2016, the DB program alone had benefits that exceeded contributions by more than $4 billion.

      When you are comparing pension returns to equity returns, you need to consider the timing – CALSTRS reports on a fiscal year that runs 7/1 to 6/30, so comparing their returns to calendar year S&P price return is often grossly misleading. Also, pension like CALSTRS typically invest across a broad spectrum of asset classes, not just in US equities. If you want to assess the effectiveness of their investment management, you need to dig into the detail of asset allocation and returns versus benchmarks by class – CALSTRS ended 2016 with significant allocations to global equities, fixed income, private equity, and real estate in addition to US equity.


  15. […] am working on a second installment of my series but this is not it.  I have noticed the comments can be very critical.  This does not bother […]


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