the mounting pension crisis -- 4/13/16

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Today's selection -- from Kentucky Fried Pensions: Worse Than Detroit Edition by Chris B. Tobe. State and municipal pensions are exempt from federal oversight (under the ERISA Act of 1974), and perhaps as a result, given pressure on state and municipal budgets, many have become dangerously underfunded. Some estimate that the aggregate underfunded position of all state and municipal pensions is in excess of $2 trillion -- portending a pension crisis in the years ahead. This underfunded position has caused many pensions to seek riskier, higher-yielding investments such as hedge funds. Hedge funds are often steered to state and municipal pensions by "placement agents" who are often politically connected and are compensated, in an apparent conflict of interest, by these same hedge funds. Kentucky's Employee Retirement System and Teachers Retirement System are among those pensions that are significantly underfunded:

"[An April 2013] National Review article [states that] 'Kentucky's pension system is a veritable horse-trading operation. Its managers are currently the subject of an SEC investigation of its payments to investment agents with ties to the pension board.' Moodys in late June 2013 ranked Illinois worst, then Connecticut, followed by Kentucky with revenues to support their pension liabilities.

"Pensions have historically been considered unhealthy if they are under an 80% funding level. Recently, a fiscally sound threshold for a public pension is a 70% funding ratio, according to Morningstar. Once they get to a 60% level they are more and more likely to never recover, or go into a death spiral. Under this criteria Kentucky has been declared a death spiral state in a Forbes piece. In this death spiral payments exceed contributions with costs rising twice as fast as investment gains, giving you no financial or return solution. Not only is the 27% funded KERS plan in a death spiral but the larger 54% funded Kentucky Teachers Retirement System (KTRS) is starting into a death spiral as well as evidenced as their plea for adding $400 million to their contribution in late September 2013.

"The mainstream press in Kentucky has only in last few years picked up on the significance of the underfunding of the single worst state plan in the country: the Kentucky Employee Retirement System (KERS). Only in the last few months they have picked up on the severe underfunding of the Kentucky Teachers Retirement System (KTRS). They still have never covered the independent counsel report to the SEC that is an appendix to this book.

The corrupt budget processes that lead to the nation's most seriously underfunded system is directly linked to the corruption in investment hiring and management through placement agents. This process 'to pay for play' is part of the same underlying culture. Every 'pay to play' and placement agent scandal has involved high fee, high-risk alternative investments like private equity and hedge funds. There are no placement agents pushing Index funds. A 2013 study by the International Monetary Fund backs this as well. 'U.S. public pension funds -- particularly the lowest-funded ones -- have responded to the low-interest-rate environment by increasing their risk exposures. At the weakest funds, asset allocations to alternative investments grew substantially to about 25 percent of assets in 2011 from virtually zero in 2001, translating into a larger asset-liability mismatch and exposing them to greater volatility and liquidity risks:'

"This Kentucky culture of corruption has not only permeated the retirement systems and the legislature, but even the supposed 'watch dogs' -- the auditors and attorney general's office -- have apparently turned a blind eye. I am especially disappointed by the lack of interest from the auditor's office, since I served as their pension expert from 1997-99. There are many boards from school and university boards to mental health agencies overseeing the individual budgets of entities in the retirement systems, which are oblivious to this crisis."