Wednesday, February 29, 2012

US Pension Liabilities

It is nearly impossible to locate a major media story documenting the problems facing the US pension system. Public and private funds alike are patently insolvent. What is more alarming is the public perception related to this condition. Take your own poll on the issue as we have done. Notice that you are brushed off as crazy for even asking the question, "Who is going to pick up this tab?" Polling participants feel confident that the government will take care of this. As always, we will attempt to properly communicate the facts so that you can apply logic and reason in predicting the likely outcome.

We have done our best to locate proper facts surrounding this issue and welcome reader submissions. The condition of state pension systems is especially alarming. A 2011 study by Bryan Leonard of State Budget Solutions found that using conventional private sector calculation methods, states faced an unfunded liability of $2.5 trillion. State and local governments have historically promised large future benefit packages to their workers.

Alabama faces an unfunded liability of roughly $10,000 for every man, woman and child in the state! How will they pay for that? JP Morgan already enslaved Birmingham with what may be the worlds most expensive water works project. The state has only so much to offer in the way of incentives to industry. Where will the revenue come from to meet these promises?

We are not picking on Alabama. The same problem exists in Yankee states. New Jersey made only 14% of the contribution suggested by actuaries this year. Where will the the remaining 86% come from?

Notice there is some key language in here which we will reference below. The funds have all reported liabilities based on their modeled return estimates. In the event that they exceed these returns, liabilities will be reduced. If the opposite occurs, liabilities will increase and further deepen the hole that they fail to acknowledge is already caving in around them.

States are not alone in their struggle. Private companies face similar issues. Mercer estimated that S&P 1500 company pensions were collectively underfunded by 25% at the end of 2011. They cite a yield-starved environment as the possible culprit. The privately owned US Federal Reserve has by decree set interest rates at 0% for the foreseeable future. How will these funds meet their 8-9% return objectives that have been used to estimate their liabilities?

How To Profit From This

As longtime readers will attest, our mission is to help you clearly see the facts and use your own ability to think in order to protect your balance sheet. We are staunchly objective and bound by a personal code that requires logic and reason be applied to every set of facts we encounter. We see a limited number of outcomes in our analysis of this particular situation.

  • Returns Exceed Expectations: This is the most desirable outcome by a long-shot. When returns exceed expectations the liabilities of the pension fund are drastically reduced. Surplus gains are allowed to count towards annual contributions reducing the cash obligations of the sponsor. Where will these returns come from? Towers Watson says that 37% of pension assets are deployed in the bond market where rates are in zero territory, far south of their 9% target return. The Dow Jones Industrial Average advanced 5.53% in 2011 again leaving a gap between desired return and actual performance. This puts a great deal of pressure on the 2% cash and 20% other holdings.

  • Government Assumes Liabilities: This is the expected outcome. US citizens believe that their government is a superhero which can defy the laws of economics, physics, and 6,000 years of behavioral human history. US government payments already account for more than 20% of incomes. That number has continued to grow while the nation finances its largess with sub-2% bond issuance. The US is already spending nearly $1.5 trillion more than it receives in annual tax revenue. The bond market has not raised any concern about this so maybe they will be able to raise that gap even higher in order to assume bankrupt pension plans?
  • A Cheaper Dollar Allows Plans To Meet Obligations: We feel this is the likely outcome. Some plans will be allowed to fail. Those of private companies outside the sphere of government influence are the key suspects. Also in jeopardy would be an insolvent state with political leadership differing from that of Washington. Remember, the playbook calls for a shock event to create the need for a public solution. If there is no need for a solution, there is no need for a modern politician. We feel that a continuing controlled devaluation of the dollar is what the leadership desires. They hope that this will increase returns in some sectors with the difference being made up by freshly printed excess currency. This currency will come from a bailout of the Pension Benefit Guarantee Corporation. This way the citizens get the nominal dollar amount promised while the real cost is reduced. Since government educated voters have been shielded from any monetary history lessons or the definition of "real" vs. "nominal", it should take them at least an election cycle to realize what has actually happened.

We genuinely believe that our assessment of the problem is accurate. Also, we feel that one of the three solutions outlined above will be utilized as an answer to the problem once it surfaces. As a fiduciary, our task is to shield capital from the fallout created by such events. In this case we would first seek assets that are not the liability of another party. Precious metals meet our criteria. When ongoing reckless currency creation is likely, we are compelled to position ourselves first in gold and to a lesser extent silver. Other options are available in the form of commonly defined hard assets. We would caution readers that assets fixed to one area carry risk. Also, hard assets that spoil or require a consumer buyer could be a problem.

If you stay aware and objective and think for yourself you will be able to shield wealth from the fallout these events will surely create.

No comments: