In this year’s annual letter to Berkshire Hathaway shareholders, Omaha’s Warren Buffett referred to public pensions as a “gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them.” He warned that local and state financial problems are accelerating because “public entities promised pensions they couldn’t afford.” (1)
While it may be easier to ignore some who are asking questions about them, it’s a bit tougher to stay in denial when someone like Warren Buffett warns these plans need attention.
Certainly the “tapeworm” effects are playing out here in Iowa. Iowa’s largest cities are struggling to keep up services as public pension contribution requirements (now more than 30 percent of salary for police and firefighters) consume a growing share of their budgets. After many years of deliberate underfunding followed by huge market losses, even the required contribution to Iowa’s largest system, the Iowa Public Employees Retirement System (IPERS), has risen 50 percent after 30 years of stable rates.
In the City of Des Moines, total public pension contributions now equal 14 percent of the general fund and 19 percent of all property taxes collected in a given year. Moody’s is reviewing local finances and more credit downgrades can be expected because of the increasing budget stress. For cities, they worry that declines in service will drive residents out, thus starting a downward spiral as the tax base shrinks. If in doubt, look at what’s happened in Des Moines over the past ten years:
Even as difficult as it has been to absorb this “financial tapeworm,” the true size of the creature is likely even greater than is currently reported. Plans can and do assume high rates of return on their investments (for IPERS, 7.5 percent per year for 30 years), meaning that lower contributions appear to be required to help fund the future obligations. Using what in their judgment is a more reasonable rate of return, Moody’s estimates the state’s share of IPERS’ pension liability to be more than twice the amount reported by the system. (2) In other words, though we’re already in a squeeze now, we should be contributing more – a lot more.
According to the largest hedge fund in the world, Bridgewater & Associates, 85 percent of public pension funds could fail in 30 years if long-term returns are closer to the return they believe is more probable than the assumptions that plans are now using. (3)
What will it take to give us a clear understanding about the service implications and the financial risks associated with Iowa’s public pension plans?
An independent panel commissioned by the Society of Actuaries (SOA) believes the answer is: good information. The panel recently released a report recommending stress-testing some of the key assumptions that determine the long-term viability of public pension plans. (4) They recommend the information be developed and disclosed to governors, legislators, unions and taxpayers so the true risks can be fully understood and decisions made accordingly.
Iowa’s public pension plans will be commissioning their annual actuarial reviews this spring. The recommendations from the SOA should be included in those reviews. They offer the best shot yet of opening our eyes to the risks, and allowing for conscious decisions to be made about how much risk we are, or are not, willing and able to accept. Then we will need to pay attention to the results!