Retiree-Benefit Monster Lurking in U.S. Economy

In 2006, at the height of the housing market bubble, we wrote a report called “The Death of Pensions.” Our main points were that the defined benefits promised to current and future retirees couldn’t possibly be paid, that the situation would get even worse when the economy turned down, and that most providers — meaning public entities — weren’t even acknowledging what they owed.

Unfortunately, we were right on target.

Private companies, many of whom realized the problems with pensions and other promised benefits before the downturn, raced to freeze, cut and/or eliminate their benefits over the last several years.

The possibility of facing pension liabilities and other benefit costs that would bankrupt them proved to be very motivating.

In their efforts, these companies first outlined the size of the issue, then the steps necessary to bring the costs under control. This is a very rational approach, which is probably why cities and states refuse to follow the same line of reasoning.

An Economy Gone Bankrupt

While Detroit and Chicago are putting their retiree benefit problems front and center, it is only because the facts on the ground forced their hands.

Detroit is bankrupt and under the control of an emergency manager. Chicago is only months away from a crushing increase in its required pension payments.

Citizens are bracing for increases in taxes and fees, while current workers face increased contribution requirements and retirees (in Detroit) face the possibility of lower benefits. Many of them, as well as employees and retirees, were shocked in 2012 to learn the extent to which their pension benefits were not funded.

These two cities avoided their pension issues until the monsters under the bed effectively ate the bed and couldn’t be ignored any longer.

While perhaps not as far along as these two basket cases, many cities and states are on the same path, with severely underfunded pensions. But at least those liabilities are listed in the financial statements.

The retiree-benefit monster that lives in the closet is not about pensions, it’s about Other Post-Employment Benefits (OPEBs), which is government-speak for health care.

Unlike underfunded pension liabilities, these promised benefits are largely unfunded, as in there is zero money set aside to pay these costs. The size of the hole is approximately $500 billion.

The Governmental Accounting Standards Board (GASB) wants to force all public entities to include their unfunded OPEB liabilities in their financial statements, instead of hiding the numbers in their footnotes.

This would provide investors, citizens, retirees, and all other stakeholders some sort of estimate about how their city or state is handling such obligations. Are they actually setting aside funds to pay these debts, or are they simply hoping that somewhere down the line the required benefit payments will simply disappear?

The Board is taking comments on the new rule through August, and then will hold several public hearings on the subject in the fall.

I fully expect cities and states to oppose this rule because it will severely affect their financial statements by adding billions of dollars in liabilities.

The fact that it simply represents reality, and at least moves us a step closer to addressing this issue by recognizing the size of the problem, probably won’t make any elected official more likely to support the rule. They’ve ignored it this long without a negative effect… right? Unless of course you live in Chicago, or Detroit, etc.

Look for the rule to pass, and eventually for cities and states to raise their taxes and fees as they begrudgingly address this half-trillion-dollar problem.

Rodney Johnson

Rodney

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.