retirement Archives - Page 3 of 4

April 3, 2017October 4, 2018

Teachers and Their Retirement Problems

teachers_financial_advice — Public School Teachers are the Glengarry Leads

A majority of people struggle to prepare financially for their retirement, but public school teachers and employees face a particularly difficult set of circumstances.

I’m enough of a fiscally hard-assed finance guy to think that every public school teacher should self-fund his or her retirement to supplement their pension plan, which for people in my state is the Teachers Retirement System of Texas (TRS). Unfortunately, there’s the grim reality facing many teachers about how hard this is to actually do. I learned a lot recently from my teacher friends about why that’s so.

My friend Dina Toland has worked as a public school teacher in Texas for 23 years and described the typical way she and her colleagues obtain their “retirement advice.”

First, a representative salesperson for an insurance or investment management company gets invited, for some unclear reason, to a faculty and staff meeting, where they have a captive audience from which they can collect email sales leads by offering raffles or some other minor incentive.

The salespeople then attempt to schedule one-on-one teacher meetings using these leads, at which the pitch usually involves scaring teachers about their insecure retirement and the need for certain specific investment products. Thus made anxious, teachers are often urged to invest in variable annuities, which I consider one of the four horsemen of your personal financial apocalypse because of their high fees, illiquidity, low returns, and generous sales commissions for these same salespeople.

Dina was convinced to buy into this mess when she was a young teacher just starting out. Ironically, the salesperson herself was so inexperienced that she convinced Dina and her cohort of similarly clueless young teachers to take out too much money from their paychecks, such that they all had trouble paying their bills in subsequent months. Besides taking too much money, they all bought into these terrible variable annuities. As Dina says, how would they have known any better?

This problem afflicting teacher retirement planning isn’t limited to Texas. The New York Times ran an excellent 6-part series last year with provocative and true headlines like “Think Your Retirement Plan is Bad? Talk To A Teacher” and “An Annuity for the Teacher – And the Broker” about precisely these difficulties, featuring public school teachers in Connecticut who were sold products with this combination of high fees, low returns, illiquidity, and hefty commissions for insurance salespeople.

My friend David Nungaray, in his 6^th year of teaching and administration in public schools in Texas, has a similarly discouraging story.

Early in his career, a representative salesperson of an insurance company was invited to speak to new teachers like him, at which he was of course urged to purchase an annuity. He did, to my chagrin when I later learned what had happened. This year he resolved to open up his 403(b) employee-sponsored retirement account, the next big option for self-funding one’s retirement.

Helping my friend David set up his 403b account was anything but easy and straightforward. David is himself extremely competent. But we agree this would never have gotten done without both of us working hard to do it. As a first step, David asked six of his colleagues in the public school system – chosen by David for their seeming prudence and likelihood to have a 403(b) account – if they had any advice for him. Only one of the six had ever signed up for a 403b account. Not an auspicious start. David then contacted his school district to look for help. Could David get any investment advice from his school district? No. The human resources department at his school district referred David to TCG Group, which administers all employees’ 403b plans for his school district, as well as many others in the state. The TCG Group website provides a list of 51 approved annuity and investment firms, with links to contact them.

David had no idea which investment firm to pick. Could TCG Group help? No, that’s not their job. They are 403(b) plan administrators only.

As a side note, I tried for three days to have a substantive conversation with folks at TCG Group, for the purposes of this post. Let’s just say they were as helpful and open with me as they were with David.

The next step was to pick an investment firm and to open an account. I helped him do that. Having done that, he returned to TCG Group to give them instructions to have 403b contributions deducted from his paycheck. Of course, then he needed to select an investment, or series of investments, at his chosen investment firm. That’s easy for me to help him with, so I did. But this hand-holding happened over the course of four weeks, with many barriers along the way. The barriers would have deterred a less determined employee, especially one without a friend willing to do it, in a non-conflicted way, for free.

Of course any of the investment firms could have “helped” him too, but he might have ended up with terrible annuity-like products totally inappropriate for the retirement account of a teacher still in his twenties. I’m all for self-funding and self-reliance as a theory, but I’ve become concerned about the reality of doing this well, for most teachers.

The stakes are high because most public school teachers in Texas – like those in many other states – can not count on Social Security in retirement, as 95 percent of school districts opt out of the federal system. So teachers fall back on the TRS and do little else.

If you are one of the over 1.5 million Texans who are members of the TRS, you should ask at least two big questions about your retirement. First, as my main safety net, is TRS financially strong? Second, will payments from TRS be enough to cover my needs in retirement, personally?

If you are not a member of the TRS, then as a citizen and taxpayer you should hope that state leadership is also asking important questions and having a good dialogue around these challenges and solutions. In a subsequent post I’ll talk about the finances of TRS, and that dialogue.

A version of this post ran in the San Antonio Express News and Houston Chronicle

Please see related post:

Public Policy Debate on Teachers Retirement in Texas

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March 24, 2017March 24, 2017

My Self-Directed IRA

With a little time to go before tax day, you’ve still got time to fully fund – up to $5,500 or $6,500 if you’re at least 50 years old – your Individual Retirement Account (IRA). As a certain former Governor of California used to say in the movies: Do it.

Today’s lesson is a departure from the solid, sensible, (maybe boring?) advice I’d usually give you regarding IRAs, and instead is about a do-it-yourself (DIY) version of IRAs that you should know about. But you shouldn’t necessarily “do it.”

But first, the boring, correct thing you should do with your retirement money: Set up automatic regular contributions to a low-cost (probably indexed) 100 percent stock fund at a brokerage house, and never, ever, sell. Also, be sure to do this starting at age 22. That’s how you guarantee your wealthy retirement.

While most of my retirement money is sensibly invested as described above, a portion of my retirement money is in a self-directed IRA. What does that mean? That means I like to make things difficult for myself. For some good reasons, and some bad reasons, which I’ll explain.

A self-directed IRA greatly expands the category of things you can purchase into your IRA. With a self-directed IRA, You can buy real estate, like raw land, a commercial building, or even a house. (You can’t live in a house owned by your IRA, however, that’s a clear No-no.) With a self-directed IRA you can invest directly in a hedge fund, a venture capital fund, or simply shares in a privately-held business or limited partnership. (Although you can’t own a business that also pays you a salary, that’s also a clear No-no.) You can even buy physical commodities like gold, for example. (You shouldn’t, but you can.).

The folks at the self-directed IRA service provider I use offer further examples of odd but potentially interesting ways to invest that go beyond the bread-and-butter stocks-and-bonds of a traditional brokerage or bank IRA. Some clever real estate folks, for example, by options on real estate for small sums of money, and then line up real estate buyers above their option price. This form of real estate flipping is a difficult but cool trick that could turn a very small IRA into something meaningful. I don’t really recommend you try this at home, I’m just mentioning things that some folks do in their self-directed IRA.

There’s definitely nothing ‘guaranteed’ about self-directed IRAs. In fact, it’s probably safe to say that one of the main disadvantages of a self-directed IRA is that there’s (almost) nobody to sue when things go wrong. That’s your own self-inflicted wound when you lose money.

An analogy I like to use for a self-directed IRAs is that it’s a lot like building your own car in your own garage. It will take a lot more work than the alternative. You probably need specialized knowledge. It may cost you more money than buying your basic Hyundai at the dealership. You can install some cool tricked-out features if you have particular skills. Still, most people would be better off, with most of their money, if they just went to a professional brokerage instead of building their own investment vehicle.

But if you build it yourself and then the brakes fail going down hill, well then I don’t know what to tell you except you made some bad choices. And also, like, you should have gone to GEICO.

The best reason for opening a self-directed IRA – probably – is that you really derive a lot of satisfaction from the act of investing itself. Maybe you enjoy taking risks. Maybe you have a very particular expertise in real estate or private investing or high-interest lending. Possibly you have access to unusual deal flow because of your professional background. Those are the scenarios that lend themselves best to self-directed IRA investing.

Mobile homes, Yay! (Not the actual mobile home in Arkansas)

Personally, I’ve done this now for seven years.

The service I use in Texas, Quest IRA out of Houston allows me to invest in some weird things, which I’ve found fun. My wife’s IRA, for example, receives regular monthly payments on a mobile home loan in Arkansas. Whenever a monthly payment comes in, I forward her a note saying “Yay Mobile Homes!” (True story.)

From my own IRA, I’m currently lending money to a friend here in San Antonio who needed to buy a piece of property and erect a structure for his business. It felt nice, beyond the annual interest rate I earn, to offer him an easier option than a bank for that purpose.

In my self-directed 401K, I acquired a fractional interest in an odd-ball piece of land in Bexar County that has at times enhanced my knowledge of real estate arcana and other times has frustrated the heck out of me. I plan to write about some of that arcana next week.

In investing via my self-directed IRA, I violate all sorts of investing rules that I urge on other people. Things like:

Don’t spend any more than the minimal time necessary on investing activities. Guilty as charged.
Have an expert analyze all the risks. Since I don’t know all the risks I’m taking, and since a professional money manager hasn’t looked into them for me, there are certainly more than the usual number of unknowns in these investments.
Don’t lend money to friends, as you risk losing both the money and the friend.
Don’t pay higher fees than necessary.

I know I pay higher fees for my self-directed IRA accounts than I do for my basic index stock fund at a major discount brokerage. I get charged an average of 0.15 percent management fee on assets with my basic stock index fund, or let’s say $150 per $100,000 per year. Although the self-directed accounts don’t have a management fee, I pay in the range of $1,000 per year, or let’s say 1 percent for a variety of account fees, on $100,000. In other words, this is more than six times more expensive than my basic stock index fund.

So again, this is as much about the fun of DIY than anything else. Have I convinced you not to do this yet? Heck, I’ve almost convinced myself. Just kidding, I enjoy it too much. And also, I probably need better hobbies.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

Please see related posts:

Agricultural Tax Exemption

DIY IRA

Tax Liens in my life

Post read (267) times.

September 5, 2016March 26, 2017

Houston We’ve Got a (Pensions) Problem

Houston’s three public pensions may not be in total distress today, but some of the instrument panels are beginning to flash orange.

One of the warning signs is the hit to the city’s credit-ratings earlier this year, as

Moody’s Investors Service downgraded the City of Houston’s debt on March 16 2016.

You might guess that the main problem with the City of Houston’s credit rating is the slowdown in the oil services business, and that’s certainly a short-term issue.

But Moody’s specifically cited large unfunded pension liabilities as one of the four main reasons to downgrade city debt to Aa3 and keep it on “negative outlook,” calling the liabilities “among the highest in the nation.” Lacking a plan to address the pensions, Moodys wrote in March, could lead to a further downgrade in the city’s bond rating.

Let’s review some statistics on the pensions for firefighters (acronym: HFRRF), police officers (acronym: HPOPS), and municipal employees (acronym: HMEPS).

Things to monitor

Remember, the first two things to monitor, with respect to the health of a pension plan, are the funded ratio – roughly how much of future payments are already covered by investments – and years to amortization, otherwise known as the time needed to pay down debts. I’ve previously said that an 80 percent funded ratio is considered ok, although closer to 100 percent would be preferred. For years to amortization, a 15 to 20 year time frame seems manageable, while 40 years to infinity invites state monitoring and restrictions.

So what do we worry about the Houston plans in particular when we see the funded ratio and the years to amortization?

Here are the two measurables on the three Houston pension plans:

HFRRF – 86.6 percent funded ratio, 30 years amortization

HMEPS – 54 percent funded ratio, 32 years amortization

HPOPS – 79.8 percent funded ratio, 23 years amortization

Honestly, using just those measurements, only the HMEPS funded ratio makes me worried. If you’re not frightened by the first two measurements of funded ratio and amortization – and when I look at them I don’t personally get panicked – the next thing to monitor gets trickier.

You see, the firefighters’ and municipal workers’ plans assume an 8.5% annual return on investments, while the police plan assumes an 8% return. Not only do all three assumptions seem too high, but the first two plans are complete outliers. In a survey done by the National Association of State Retirement Administrators in early 2016, only 1 out of 127 plans assumed an 8.5% return. So, Houston firefighters and muni workers have an aggressive – actually my preferred word would be unrealistic – set of assumptions.

Last Fall, the Chairman of the HFRRF Todd Clark defended their outlier return assumptions in the Wall Street Journal, saying “We strongly believe, and past history shows, we can continue to achieve the 8.5% long term.” Clark resigned in July. HFRRF Executive Director Ralph Marsh declined to comment on my questions about the assumed return, or others posed about their pension fund.

The last 20 years’ average pension returns were 7.47 percent, according to the Wall Street Journal.

As a finance guy, I wish I could intuitively explain to the non-finance reader the uncomfortable tingly feeling in my toes that I get about that math. The effects of being wrong by just 1 percent, compounded over decades in a pension plan, are huge. We can see some of the scary implications from a presentation done by the Houston plans for the Texas legislature in June.

In that presentation, they showed that if you shift the return assumptions on Houston’s police and municipal employees down by 1 percent, suddenly the police pension plan only has a 54.6 percent funded ratio, while the municipal employees plan goes to a 49 percent funded ratio. So, like, only half the money needed to pay out retirees is currently available in the plans. Ugh. The instrument control panel not only shows blinking green lights turning into red lights, but sparks are starting to shoot out of the dials. Danger Will Robinson!

Now you start to get a sense for why Moodys downgraded the City of Houston in March, and why the Chairman of the Pension Review Board is trying to sound the alarm on Houston pensions.

City Budget Constraints

You see, the next big problem is that fixing pension shortfalls begin to eat into city budgets, a process already underway in Houston.

Josh McGee, who serves as both the Vice President of the Laura and John Arnold Foundation – a Houston think-tank focused on public finance, as well as the Chairman of the Texas Pension Review Board – points to a worrisome trend for Houston’s city budget.

In 2001, required pension contributions made up just 6.7 percent of general fund revenue, or the amount of money in the city budget not otherwise allocated to specific purposes. By 2015, the required pension contributions have climbed to 19.2 percent of the general fund. The trend here, tracked by McGee, has been steadily upward.

McGee compares Houston’s situation today with Chicago’s situation a decade ago. In Chicago, the comparable pension payment to the general fund rose from 19 percent to a stunning, and devastating, 54 percent today.

That means city leaders can’t decide to pay for stuff in a city without dedicating half their discretionary budget to fill in holes in pension plans – money already owed to workers, for work already performed. You have to rob Peter to pay Paul. Chicago is in a terrible bind today, and McGee openly worries Houston will follow down that path without a course correction.

So what happens if these plans stay in trouble? Realistically, political leaders don’t just say “Whoops” and send a shrugging emoji to pensioners. They especially don’t do this with politically sensitive pensioners like police, fire and city employees.

No. Instead, they fund the plan, and then taxes go up. Or they fund the plan, and other discretionary city services go way down.

The only other fix is to significantly reduce benefits for future employees.

Either way, residents previously blissfully unaware of such boring actuarial minutia as funded ratios, amortization schedules and actuarial unfunded liabilities unhappily begin to care, deeply and late, about such problems.

A version of this post ran in the San Antonio Express-News and the Houston Chronicle.

Please see related posts

The Dallas Police and Fire Pension Mess

Pension Plan Heuristics

The Big Four Texas Pensions

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August 29, 2016September 5, 2016

Public Pensions – The Big Four In TX

A key reason why I started a discussion of public pension funds in Texas by saying “Don’t Panic” is because 88% of Texans covered by a public pension plan are participants in one of just four plans, and the good news is that none of these four are in distress. Right now.

The largest four pension plans – Teachers Retirement and Employee Retirement System (TRS), Employees Retirement System of Texas (ERS), Texas County and District Retirement System (TCDRS) and Texas Municipal Retirement System (TMRS) – cover over 2 million Texans. So no distress means you can stay calm.

On the other hand, if you had a worrying kind of paranoid view of public pensions – like I kind of do – you would notice that size should inversely correlate with complacency. The bigger they come, the harder they fall, as Jimmy Cliff and others point out.

The problem of size

If the Teachers’ pension system goes poorly – or any of these four go poorly – we can’t rely solely on my three rules of thumb to alert us.

We need an additional layer of scrutiny because the absolute scale of the problem is what we should worry about. The bailout for miscalculating on this scale might swamp the state budget.

This is what people in California worried about in the aftermath of the Great Recession in 2010, or what people in Illinois this year worry about. Namely, might the entire state of Illinois have to seek bankruptcy (or its legal equivalent) as a result of unfunded pensions?

Review of the Big Four

Four state pension plans dominate the Texas public pension scene, with over 2 million Texans participating.

Of these, the Teachers’ Retirement System (TRS) is the big gorilla, about six times as big as the next biggest pension system, with about 1.5 million members and over 150 billion in assets, as of its 2015 report.

The funded ratio of the TRS – the ratio between estimated assets and estimated liabilities, stands at 80.2 percent – or just at the point where reasonable observers feel comfortable most of the time. Remember, 100 percent means fully funded, but many funds do just fine running in perpetuity in the 80 to 90 percent region.

Meanwhile, the time to amortization – the estimated number of years it will take to fully fund teachers’ pensions – stands at 33 years, which is a bit on the high side. The Pension Review Board would prefer 15 to 20 years, but according to the state legislature, 40 years is the panic point, statutorialy speaking.

Finally, TRS estimates investment returns of 8% going forward, which seems too high to me, roughly in the top quartile of estimates. It’s not totally out of line with other pensions nationally, but it’s not a conservative estimate either.

One of the next biggest, the Employees Retirement System of Texas (ERS) resembles TRS in the sense of a 76.3 percent funded ratio, as well as a 33-year amortization, or time to pay down its unfunded liabilities. Back in 2014, the ERS reported an “infinite” amortization time period, essentially meaning it would never pay off its debts. So while 33 years is uncomfortably long, it also represents a step in the right direction from the previous years. The ERS also assumes an 8% return, which again isn’t conservative.

The two other big pension systems right now appear in healthier shape than either TRS or ERS. The Texas Municipal Retirement Systems (TMRS) scores higher than the first two, with a funded ratio of 85.8 percent, and an easier 17-year amortization. It’s 7 percent return assumption also means it has more room for error in its model, in case markets do not cooperate over the coming decades.

Meanwhile, the Texas County and District Retirement System (TCDRS) has a pretty comfortable 90.5 percent funded ratio, meaning estimated assets cover nine-tenths of estimated liabilities. In related news, actuaries estimate it will take only 9 years to amortize its debts. These levels for the TCDRS look good enough that the 8 percent return assumption feels less threatening.

Taken as a whole, these four systems indicate acceptable levels of risk as of now. They also mostly compare favorably with pension systems in other states.

A little panic

Ok, do you want to be a little bit scared? Fine, I’ll help you.

Josh McGee, Chairman of the Texas Pension Review Board, points out that these four big pension plans in general, and the Teachers Retirement System in particular, run an additional risk beyond the normal risk – simply based on their massive sizes.

pension_liabilities — “You want to see something really scary?”

You see, if a small pension plan goes bust, a responsible government entity has a problem of filling in the hole, but the hole might be, and hopefully is, manageable through belt-tightening, cutting future benefits, and higher taxes.

But the TRS, with an unfunded future liability a little more than $33 billion, is too big to fix, if something goes terribly wrong.

Just to attach a sense of scale to the $33 billion figure, the state of Texas spent about $112 billion on everything last year, so it’s not like a $33 billion hole can be solved by any reasonable measures. TRS looks fine-ish right now, but failure is too big a financial risk for the state to run, so extra caution is needed.

I still say “Don’t Panic” but I’d also say don’t get too comfortable either. A little bit afraid might be just right.

A version of this post ran in the San Antonio Express News

Please see related posts:

Public Pensions – Don’t Panic, Use Heuristics

Public Pensions – Dallas Police and Fire Pension System Clusterfck

Public Pensions – Houston Might Have a Problem

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August 18, 2016March 26, 2017

Public Pension System Heuristics

Douglas Adams’ Hitchhikers Guide To The Galaxy famously advised us on the book cover “Don’t Panic,” and I think that’s a useful starting point for discussing public pensions in Texas.

You see, I started by wondering “should we panic?” when I began a personal project of studying public pensions, for a variety of reasonable suspicions, which I’ll share. After sharing my suspicions, I’ll tell you what I think the informed citizen – that’s you and me! – should worry about, and monitor, with respect to Texas pensions. Next week I’ll tell you specifically more about the biggest public pension plans in Texas.

The stakes for these multi-decade math models are particularly high for cities and counties that offer pension plans to employees.

Just ask the folks of Central Falls, Rhode Island (2011), both Stockton and San Bernardino, California (2012), and Detroit (2013), where insufficiently-funded and/or overly generous pensions sent those governments into bankruptcy protection. The City of Chicago is currently engaged in a multi-year game of chicken over its pension benefits. Some see bankruptcy as the future for Chicago, or possibly its public school district.

My suspicions

My first suspicion began because we’re in an environment of extremely – historically significant – low returns from bonds, such as 1 to 2 percent over the next ten to thirty years. Meanwhile, almost all public pension plans in Texas routinely model a 7 to 8 percent annual return over decades. That assumed annual return matters because with even a moderate allocation to bonds, risky assets like stocks have to make up the difference. Stocks and other things in the pension investment portfolios – like private equity and real estate – have to return 10 percent or more on average – every year for decades – just to make up the high returns that bonds can’t. That seems like an uncomfortable assumption over the next few decades. That made me suspicious.

On top of the current market environment, pension plans always represent some of the most complex financial systems in the universe. Complexity makes me suspicious too.

Actuaries, the poor souls charged with solving the math problems to figure out whether pensions will support public workers in old age – or conversely drive governments into bankruptcy – have a lot to keep track of.

Tracking the money going into a pension may at first seem relatively straightforward, depending as it does on employee headcount, employee salaries and contributions, and employer contributions. It gets a little trickier when you have to make assumptions about long-term investment gains – for the next thirty years.

Money paid out of a pension plan, however, really increases the complexity. The easy part of the equation here are the costs of administering a plan. The hard part comes from the fact that payouts generally continue for the life of workers. We don’t know exactly when people will die, so actuaries have to accurately model the expected length of the lives of workers. They also have to estimate when workers will separate from employment, and when they will claim benefits, and how much those benefits will be. On top of that, they have to model such things as dependent-spousal benefits, as well as rates of disability, both of which increase benefit payouts.

Ideally, these actuarial estimates need to work over long time periods. Contributions made to support a thirty year-old worker today may need to fund payouts for that worker fifty years from now. That’s a long time to estimate anything.

It seems analogous to those scientists at the Southwest Research Institute in San Antonio who planned the science behind the New Horizons space probe of Pluto launched in 2006 who then waited for a few seconds of planetary flyby in deep space in 2015. I picture these scientists sort of praying at launch ten years ago, like, “I hope our math works?”

No, pensions are easier (although in some ways harder!) than that Pluto mission, because there’s a political component to public pensions. If the teacher’s or policeman’s fund runs out in ten years, they don’t just throw up their hands and say “whoops, don’t worry about it.” Instead taxpayers – that’s you and me – will pay one way or another to honor previous public pension commitments, even if generally future retirees after that take a hit as well.

So how do we make sure public pensions are on the level, despite their complexity, and despite historically low returns from bonds?

One answer is first, not panicking. And then, vigilance. That’s what former Texas State Comptroller Susan Combs urged through her office with the publication of the 2014 report “Your Money and Pension Obligations,” and the creation of a searchable pensions database.

But how to you continue vigilance in the face of all the complex moving parts of public pensions?

I’m a big fan of that Texas Transparency site. You can see important data online, and I’m here to tell you the three things to look for in that public data.

Heuristics

My frequent answer to complexity: Heuristics! (I love that word.)

I mean, rules of thumb. Here are the three main rules of thumb that pension board members use to figure out whether their plans are healthy or in trouble.

First: Are liabilities (future payouts) at least 80 percent covered by money already in the pension plan? This is called the “Funded Ratio.” If you’re at 80 percent, then you’re pretty good. It doesn’t have to be 100 percent. Less than 60 percent and you’ve got a potential problem.

Second: If you have a shortfall – meaning your future payouts are less than 100 percent funded – then how quickly can you pay down your debts? Is the estimated time to pay off any pension shortfalls between 15 and 25 years? If yes, then according to the Texas Pension Review Board (PRB) you’re probably good. State law (HB 3310) and PRB Guidelines sets up a maximum of 40 years or else they start to get all up in your pension’s grill with reporting requirements and restrictions on benefits.

Third: Are the return assumptions over the next thirty years reasonable?

Reasonable right now means something kind of within the range of what other pension plans assume. NASRA – The National Association of State Retirement Administrators, but you probably already knew that – reports the average return assumption nationally as 7.62%.

As I’ll mention in a follow-up story on Texas’ Big Four Pension plans, three out of four of the state’s biggest pension plans assume annual returns above that average, with an assumed annual rate of return of 8 percent. Sadly, we can’t expect Texas to be the financial equivalent of Lake Woebegone, where all the market returns are above average. I wouldn’t conservatively plan on anybody consistently being able to earn an 8 percent return over the coming decades, especially when bonds return 1 to 2 percent. And even small “misses” on that measure, compounded over decades, can cause huge headaches down the line.

So yeah, I’m worried about that measure for millions of public employee retirees, and then I’m worried for all the taxpayers acting as unwitting backstops to those pension plans.

A version of this post appeared in the San Antonio Express News.

Please see related post:

Dallas Pension Plan – An Example Of What Can Go Wrong

The Big Four Texas Pensions

Houston Pensions – Worth Monitoring

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August 8, 2016September 5, 2016

Dallas Pension Plan – An Example of What Can Go Wrong

I’ve become a bit obsessed with public pensions this month.[1]

As a lesson in how pensions can go wrong, I began looking into the Dallas Police and Fire Pension System.

Dallas’ Police and Fire Pension ranks as the tenth largest in the state and easily qualifies as the most dire, according to the usual metrics of a public pension plan.

Public pensions can confound us through both mathematical as well as political complexity, but let me tell you in simplest terms the depths of the problems of the Dallas Police and Fire Pension System.

One measure of pension-plan financial health – the unfunded liability per member – marked the Dallas Police and Fire Pension system last year as the worst-funded pension in the entire state. “Unfunded liability per member” is a calculation of all the future payments owed to pensioners for past service, that isn’t covered by money in the plan, and then divided by the number of members in the plan. With a whopping $213,712 unfunded liability per member in 2015, Dallas’ pension is far worse than the next large-ish unfunded pension liability per member of $128,576, an unfortunate distinction claimed by the Houston Police Officer Pension Fund.[2]

But that was last year, and things have gotten a lot worse in Dallas.

Ten years ago, the fund reported an 89 percent “funded ratio” – which is a short-hand number for how much of future payouts are covered by invested assets. Healthy pension plans generally don’t have to have all future payments covered, but an 80 to 90 percent funded ratio range feels comfortable, and Dallas’ did.

After the departure of Executive Director Richard Tettamant in mid-2014, fund values in the pension began to drop precipitously. Sudden write-downs of the value of the real estate (31.7 percent) and private equity portfolios (20.2%) followed in 2015.

The FBI raided the offices of the fund’s real estate advisor CDK in April 2016. Meanwhile, the pension fund and CDK filed lawsuits against one another.

As Kelly Gottschalk, the Executive Director who took over in 2015 told me, “Everything that could go wrong with pensions has gone wrong with this pension.”

The funded ratio fell from 64 percent in 2014 to a recently updated 45 percent by mid-2016.

In simplest terms the 45 percent funded ratio means there’s only about half the money in the pension plan that there needs to be for retired police and firefighters.

The losses in investment assets form only part of the pension’s problem. An extremely generous retirement scheme begun in 1999 called a Deferred Retirement Option Plan (DROP) allowed officers of qualifying retirement age to continue to work full-time, while receiving guaranteed pension payments paid into a special account which earned a generous and guaranteed return. They essentially “double-dipped” on pension payments and salary. Some of these benefits are in the process of being rolled back, but the latest attempt to do so has resulted in further litigation. Naturally, nobody likes giving up a good employment deal that they’ve been promised.

How to solve a problem of this magnitude?

Gottschalk will present to the board this Thursday the years-long work of a subcommittee trying to puzzle this out. I don’t have a crystal ball into what she’ll propose, except we can guess the only available bailout methods are:

Employees and the City of Dallas start putting in a lot more money every year
The fund borrows more money
Retirees get their benefits drastically cut

None of these will be fun for anyone. None of these will seem fair.

Up until now, Gottschalk says, the City of Dallas has always paid its full share to keep the fund on track financially.

To solve the hole now, she says, the pension is “roughly getting one half of what we need.”

And yet as Dallas City Councilman Philip Kingston, who sits on the pension’s board, told me, “that is politically an extremely difficult argument to sell. That’s going to go over like a lead balloon. I have consistently told my colleagues on the [Pension] board not to expect much.”

Ironically, within a month of being tragically reminded in Dallas of the dangers of being a uniformed officer, we’re about to see their financial bargain get a lot worse, one way or another.

Now, if you’re neither a police nor fire retiree, nor a Dallas taxpayer, why should you really care about Dallas’ failed pension plan? What’s the big deal?

Just this, in two steps. First, their public pension catastrophe could happen in your city or state. Next, if it does happen, taxpayers – one way or another – pick up the tab.

Public finance conundrum

Here’s the start of the classic problem that makes public pension-planning a nightmare, almost inevitably: Decisions made in any year – most importantly the bad decisions – don’t tend to show up as grievous errors until many years or possibly decades later. Fiscally prudent decisions, conversely, take years to “fix” pensions. Meanwhile, there’s a political negotiation going on today, naturally, in setting pension terms for public employees.

Dallas’ situation on the investment side was an unfortunate self-inflicted wound, but I think their broader struggles are symptomatic and shared by many public pensions.

Police, fire, teachers, municipal, and county employees want good benefits in their retirement. In fact, they rightly deserve strong consideration from political leaders as well as from taxpayers. I start with the view that they are all highly deserving of a comfortable retirement.

And yet, small decisions about how generous to be can compound into massive fiscal headaches in future years, long after most political office-holders have left their job. Small errors – or in the case of Dallas, large errors – in investment management can also compound into public liability nightmares over the years.

A few brave political leaders may understand the long-run problem, but they will be pulled in difficult directions by their constituents. Yes, leaders report to taxpayers generally, but specific pensioners can be awfully persuasive right now, this year, with their retirements at stake. Pension beneficiaries don’t have the big picture necessarily in mind, and they are hard to resist.

Ticking financial time-bombs

As a result, public pensions resemble little financial bombs planted underneath our local governments. A few people know they’re there – hidden, ticking – waiting. Pension plan actuaries – the math nerds hammering away like underground gnomes running their sophisticated models – know what’s buried underneath the public square. But who’s really listening to the tapping and ticking?

So these public pensions bombs wait until probably the worst possible moment in the city or state to suddenly rip a hole in our public finances.

This danger inherent in public pensions has no permanent fix. I’m just pointing out that eternal vigilance is not only the price of liberty but also a necessary component of public pensions. So do you want to join my little obsession and work to understand this stuff?

I plan to write a “pension explainer” in a follow-up post so you can know what to look for.

A version of this post ran in the San Antonio Express News.

Please sell related posts:

Public Pension Heuristics – An Explainer

The Big Four Texas Pensions

The Impending Houston Pension Problem

[1] I know, I know, I need better hobbies, and I can’t seem to care enough about Pokemon Go to get past Level Five. And seriously, you guys, public pensions are arguably as important to our future as finding Pikachu. Maybe more?

[2] To look up the data on public pensions in Texas, check out the useful Texas Transparency site.

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