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Pensioners, Taxpayers in for Nasty Reality Check

Written By: Tom Hankes  |  Posted: Saturday, July 7th, 2012

You Can't Squeeze Blood Out of a Turnip

Public pensioners and taxpayers are in for a nasty reality check 

            A June article found on discloses to California taxpayers that in two years, the number of six figure pension recipients has climbed from 16,000 to over 21,000.  They expect to see over 100,000 in the 100K club in another 5 years.  According to a PEW study, the State has a pension underfunding problem of 500 billion (mathematicians will note this equates to $13,262 on average or $30-35,000 per family).  Does any rational person really think those promised pension fund benefits will ever be funded?   It was just a few years ago that this was equivalent to the national debt.  The collateral to support the exaggerated or fraudulent promises is just not going to be available.  The estimate is four trillion nationally.  With respect to public pensions, virtually every pensioner is going to find out that many of these paper promises cannot be met.

          Clearly governments across the country are struggling mightily to meet all their financial obligations.  As bad as it looks, it is actually much worse.  These figures were calculated near a market peak with assets at dangerously high levels.  Additionally, note that the average pension fund to this day still assumes a 7.5 - 8% return on their portfolio and calculates the underfunding amount based on this assumed return.  8% is an imaginary goal that cannot be achieved in these markets.  In contrast, corporate pension funds assume a more moderate 5.7% return.  This 2.3% return makes a huge difference over decades.  8% was selected as a target because politicians and actuaries knew that allows for smaller fund contributions thus alleviating more immediate pressures.  Nationwide, contributions made in 2010 came to only 34% of actuarially determined funding requirements.

          How did taxpayers in California and elsewhere get saddled with such huge liabilities? Politician greed, dishonesty, corruption, and conflict avoidance are the main ingredients.  You get the government you voted for.  The financial interests of bargaining agents for the taxpayers frequently line up more closely to the folks they are bargaining with than the taxpayers they represent - a sad conflict of interest. 

          Government leaders used time tested techniques for reducing friction with the public bargaining units: issue bonds, make attractive pension promises and postpone a lot of the pension fund contributions.  Thus public officials could preserve cash for other more visible and pressing needs such as roads, schools & Medicaid.  Unions frequently outgunned the negotiators and were rewarded with outsized pension promises (from a private perspective anyway).  The politicians and government managers largely avoided nastier negotiations required by fiscal reality, placated the feisty unions, and handed the final bill to their successors who must figure out how to meet the pension funding requirements.  The bill is coming due and payment will be difficult.  Foreigners are balking at additional funding and Bernanke's bag of tricks is empty.

          A recent news article notes Wisconsin is the only fully funded state pension plan, which means Wisconsin is more successful than other states in taxing its citizens to fund the generous pensions.  7 Best/Worst Funded State Pension Funds 2010The smiles in Madison are premature.  The Wisconsin Retirement System is proud of its fully funded status, but the lofty status has not yet been tested by the ravages of a severe bear market which has yet to run its course.  I remind readers of the 40% drop in the variable fund in 2008-09.  The majority of professional investors do not learn from history.  The proof of risk is ubiquitous: funds are fully invested with minimal cash near a market peak.  It gets worse: nationally, retiree health care is only 5% funded with estimated liabilities of 666 billion and assets of 33 billion.

          As a Wisconsin taxpayer you should care about the level of funding in the Wisconsin Retirement System as you will be required to pony up the difference at a time when your own 401K and IRA accounts have been mauled by hostile bear markets.  It's the law; your legislature so generously provided it to recipients years ago in the 90's bull markets.  Some factors working to build hostility against the level of public pensions are: Declining take-home pay and net worth, rising tax rates on families, a resource intense aging population.  The bitter aftertaste of public union and Democratic Party antics after Walker's election and the unjustified recall election will all add to voter reluctance to pony up for what are viewed as excessively rich public pensions.  This will get really ugly nationally when the scale of the greed foisted on the public and the empty promises made to the pensioners come into focus.  We are in the initial stages of a move to a type of currently funded 401K system for the public sector.  Current and future public pensioners will never forget the broken promises and will demand cash on the barrelhead as they should.

          Independent Advisors, Inc. - a Wisconsin Registered Investment Advisor, Cell: (715) 579-8125

          IMPORTANT DISCLAIMER:  The concepts expressed herein are solely those of Independent Advisors, Inc.  They are not to be construed as personal investment advice for any reader.  I do not know your specific situation. Any investment can lose money. Past performance is never indicative of future performance. Any strategy articulated in this column can be risky and can result in losses if implemented improperly.  We may or may not maintain client positions in any securities discussed. Discuss these strategies with your investment advisor or call us for more information.


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