Upon graduating college, students of all majors, minors and degree specializations must make the choice between private and public sector employment. Whether you are an art or business major, there are career options in both domains. A job in the private sector, generally speaking, pays more with an increased risk of termination depending on both your personal and the company’s overall performance. On the other hand, employment in the public sector is generally lower paying but more secure and often comes with the guarantee of a generous pension package. Both of these paths have their merits and negative aspects. However the increasingly growing crisis in pension funding should make new graduates think twice about where they seek employment and also how they choose to begin to fund their retirement.
Before discussing the current state of our public pension systems, we must understand how they are supposed to operate. A pension is a future stream income that is paid out of a fund that both employees and employers pay into while an employee is working. Then the money in the fund is invested in order to increase its value over time. All pension funds are different, but most of them expect a 7.5 percent annual rate of return on their investments, a high standard in today’s world with the risk-free U.S. 10-Year Note rate at 2.5 percent. Due to decreasing investment returns, pension funds have been feeling the burn the last few years. This is only compounded by an ever-growing supply of pensioners that need to be paid out. To better illustrate how this works, information from the Chicago Municipal Empolyees’ Annuity and Benefit Fund, or CMEABF, will be used.
In 2015, the CMEABF had a total of $4.39 billion dollars; this money goes towards paying pensions and investing to grow the fund. Also, in 2015, the fund paid out $700 million to pensioners, representing roughly 15 percent of the funds value. Employers in 2015 paid roughly $160 million dollars into the fund, a sum that does not even come close to covering what needed to be paid out. To add to the problem, in 2015, the fund earned 2.3 percent on its investments, far below the 7.5 percent assumed rate of return. While this was actuarially “smoothed” into a 6.9 percent return, the pension still falls dangerously far from being able to pay future pensioners. The annual financial report listed CMEABF as being 32.4 percent funded and warned readers in a bolded font that by 2025, barring any drastic changes, the fund would be broke.
The Chicago Municipal Empolyees’ Annuity and Benefit Fund is one of hundreds of city, town and state pension funds across the country. This specific one is for employees of the city of Chicago that are not teachers, firemen or police men. Illinois and California are two of the most underfunded states in regards to their state and municipal pension systems, but when taking into account the Federal governments obligations through Medicare and Social Security, the total liabilities are astronomical.
Slowly but surely more and more people are becoming aware of the massive issue that will come to a head within the next five years. With the number of retirees increasing every year due to the baby boomers reaching the age of retirement, pension funds are becoming ever more strained for cash. Between the catastrophic 2008 financial crisis that wiped out vast amount of investment funds and the last eight years of zero interest rate policy that has kept bonds yields, a primary investment tool of pension funds, historically low, pension funds are hurting. The last large cause of underfunded pensions is the lack of funding provided by state and local governments to cover the unsustainable promises made to their employees.
Employers that promise pensions must continue to pay retirees, who are living increasingly longer lives, while at the same time hiring new employees to fill the retired persons vacancies. While new employees generally earn less than what their predecessors made due to the age and experience gap, this system is not sustainable. Like Social Security and Medicare on the federal level, employee pensions are the biggest crisis facing state and local governments today.
Underfunded pension funds are ticking time bombs with quickly burning fuses that will only grow shorter if returns on investments continue to fall far below their “smoothed average” and employers do not increase their contributions. Hopefully lawmakers will figure out a way to solve this massive crisis. It is essentially impossible for the most underfunded pensions to invest their way out of this debacle, so a new solution must be found. Whether that solution is a decrease in benefits, mandatory increase in contributions or an as-of-now unknown solution is anyone’s guess. In any case, something must be done to solve this massive funding shortage.
February 1, 2017 @ 10:09 pm jim palermo
Excellent article, Mr. O’Connor. There’s plenty more to say about public pensions funding; I hope you’ll continue to write on the topic.