"It profits me but little that a vigilant authority always protects the tranquillity of my pleasures and constantly averts all dangers from my path, without my care or concern, if this same authority is the absolute master of my liberty and my life."

--Alexis de Tocqueville, Democracy in America

Tuesday, October 2, 2012

Don't Be Afraid of Islamists, Be Afraid of Actuaries

When you think of the "national debt" you think of the $16 trillion we owe in government borrowing.   We don't think of the unfunded liabilities of the future, all of which depend on rosy scenarios concocted by government actuaries about future economic growth, etc.   If that growth doesn't materialize, everything we think we know about our ability to pay for the promises we've made goes out the window.   I mean Medicare and Social Security primarily, but there's also the sticky wicket of all the promises we've made to our government employees.

Consider these facts from an article in Pensions and Investments:

1.The average funding ratio of the largest 100 public pension plans is 73.64%.  

2.  Those plans have roughly $2.72 trillion in assets.

3.  The unfunded liability of those plans is approximately $793 billion.  That's money we owe to government employee retirees in the future that we don't have now.

4.  But (and here's the big "but"), the plans have an average actuarial investment return assumption of 7.84%.   That means that the plans assume that they are going to average an investment return of nearly 8% a year, every year, for the 50-60 years they'll need to be in existence to fund promised benefits for current employees.  

5.  But the same plans over the past ten years have achieved an actual average investment return of only 5.6%.

6.  And the same plans in 2011 received "only" $111 billion in employee and employer contributions -- tax dollars that go nominally to the employees as wages or the employer, but really go straight into the pension funds.   But they spent $182 billion in benefits to retirees!   They are paying out more than then are bringing in by a whopping $70 billion a year.   So they are entirely dependent on investment returns to make up the difference.   But the returns aren't making up the difference and haven't for at least the past 12 years.

7.  More importantly, the same plans all calculate -- because this is the way actuaries do it -- their liabilities for future benefit payments owed to retirees by discounting those future benefits back to the present using the investment return assumption.   So a payment due twenty years from now is discounted back to present value at 8% or so.   If they used a lower investment return assumption/discount rate, say, 5.5%, i.e., something closer to what the actual returns have been for the past decade, that would add enormously to the present value of that future payment, and hence add to the plans' liabilities.  

8.  A rule of thumb among actuaries is that 100 basis points in a discount rate changes liablities by about 10%.   So 250 basis points, from 8% to 5.5%, might add 25% to these plans' liabilities.

9.  Which means that the unfunded liabilities of $793 billion could actually be closer to $1.5 trillion.   That's 10% of the current national debt and more than a year of the current federal deficit! 

10.  Yet very very very few people even know about this "debt."  

And, of course, this is just the "top 100" plans.   The debt is actually much, much larger when you add in all public employee plans.

Not very rosy of a scenario, is it?

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