Unfunded Pension Liabilities
Ugh!
Act One. The Set Up
Client (C) to Advisor: What’s an unfunded pension liability?
Advisor (A) to Client: Why?
C: Because.
A: Why?
C: Because.
A: Because why?
C: No, because why is on second, because is on first.
A: What is this, an Abbott and Costello routine?
C: Ha Ha.
A: Never mind.
C: I read about it in Barron’s (April 28th)
A: Your read Barron’s?
C: Yes, of course. You encouraged me, remember?
A: Right.
C: Anyway, it said that I might never receive the pension that was promised to me by my municipal agency?
A: Who did you work for?
C: The sewer commission. They promised me a full pension after twenty stinking years.
A: What did you do for them?
C: You really want to know?
A: Yes.
C: I was a pooper scooper.
A: Actually, no, I really don’t want to know.
C: You asked me.
A: What else did Barron’s say?
C: It said that states and public agencies generally assume their discount rate to be 7.5%, when in reality it's only 1%.
A: That’s true.
C: What’s a discount rate?
Act Two. Believe it or Not
A: Let’s start with a few facts. How much is your pension?
C: $20,000 per year.
A: How old are you?
C: 40.
A: And how long do you think you’ll live?
C: Another 100 years.
A: That’s rather optimistic.
C: I keep hearing we’re an “aging” population.
Act Three. The Skinny
A: Okay the discount rate. Your pension is $20,000 per year and you will live another 100 years. That means the sewer commission is promising to pay you a total of $2,000,000, correct?
C: Wow, yes.
A: But they don’t put it all into your account tomorrow.
C: Why not?
A: Because they don’t have to. They put only some into it and earn income on the balance.
C: Like from Amazon going up, Apple paying a dividend, or the government paying interest on a bond?
A: Wow, have I taught you well.
C: Thanks.
A: So over 100 years they have an obligation to you, or a liability to them, to pay you the pension.
C: Oh, so that’s a liability?
A: Yes. According to the article, they say that they can earn 7.5%, that's called the discount rate, to pay the liability. In order to pay you $20,000 for the next 100 years earning 7.5%, that means they have to put $267,475 into your account today.
C: How do you know that?
A: I have an HP 12C.
C: What’s that?
A: It’s a calculator I’ve had since 1981. Nothing better has ever been made.
C: Wow.
A: Okay, now let’s say that they only earn 1%, which is what they actually earn. If they fund your pension today with $267,475 and they pay you $20,000 per year, in 100 years they will actually have a deficit, or an unfunded pension liability, of $2,686,158.
C: That’s crap.
A: So to fully fund the pension, they can do three things. First, they can cut your pension.
C: No………!!!!!!!!!
A: Second, every year they can put more money into your account.
C: Great idea.
A: But they don’t have any more money.
C: Why not?
A: Because they spend more than they earn and they’re maxed out on their credit cards.
C: And the third way?
A: They can get the money from the sewer commission, which has an obligation to fund the pension first and everything else second.
C: That makes me feel better.
A: Oh, really? If the sewer commission has to pay more to the pension, they won’t have enough money to pay for other things, like building more sewers. Over time, expenses go up and more people move into the sewer district. Then when it rains, more sewers overflow.
C: That stinks.
A: Anyway, that’s an unfunded pension liability. The sewer commission is giving you bull when they tell you they can earn 7.5% per year when they can only earn 1%.
C: Why would they do that?
A: To get themselves re-elected and to build sewer lines to their second homes.
C: Can they really get away with that crap?
A: Yes, they can and they do doo, sorry I meant do too, and, to borrow with a twist from Abe Lincoln, they fool all of the people all of the time.
C: Thanks for the lesson.
A: Anytime.