What is an annuity cash flow calculator? What is the net present value of a stream of income? Why are the public employee unions so concerned about it? Okay, if you were forced to endure a teachers union led education in the Portland Public Schools, you need to stop right here, turn on Keeping up with Kardashians and hold your participation trophies close to your heart because the rest of this article is not for you.
The Dallas Morning News reported last week:
“Mayor Mike Rawlings is asking a judge to do what the Dallas Police and Fire Pension System won’t: Stop the run on the bank.
“Rawlings filed a lawsuit Monday morning against the pension system at his own expense and as a private citizen. He is asking for an emergency temporary restraining order and a permanent injunction on the system’s payments of hundreds of millions in lump-sum withdrawals, which have threatened its solvency.
“The lawsuit is the latest dramatic turn in an increasingly contentious fight over the future of the public safety retirement system, which is set to go broke within the next decade or so. Rawlings has been frustrated with the system for years. But in recent weeks, he has taken center stage in the battle.
Later in the week it reported:
“The Dallas Police and Fire Pension System’s Board of Trustees halted lump-sum withdrawals from the pension fund, ending $154 million in withdrawal requests that were set to pay out Friday. Pension officials said allowing the withdrawals would leave them without the liquid reserves required to sustain $2.1 billion fund.
“‘Our situation is currently critical, and we took action,’ Board chairman Sam Friar said.
“Mayor Mike Rawlings had filed a lawsuit earlier in the week against the pension system at his own expense and as a private citizen. Dozens of retirees rushed to request withdrawals after the filing.”
Most public employee pension funds permit a lump sum payment – including Oregon. Most lump sum pension payments – a one-time cash payment – are based on an annuity cash flow analysis. An annuity cash flow analysis, in its simplest terms, is a calculation of how much capital (principal) must be invested in order to produce a known stream of income (the monthly pension payment) over a known period of time (the actuarial determined life of the recipient) assuming a given return on the capital. The equation for determining this can get pretty complex particularly when you introduce an annual percentage increase for the monthly payments for “cost of living” increases. But for demonstration purposes we will assume that pension payment will remain constant – no cost of living adjustment. I used an annuity calculator provided by Bankrate.com. For these purposes let us assume that the monthly pension payments will be $5,000.00 per month for a life expectancy of 25 years (300 months) and that the rate of interest is 2.0 percent (about that of a 10-year money market investment). The annuity calculator determined that it would require an amount of $1,181,616.63 to produce that level on monthly pension payments using that rate of interest over that many months. If you change only the interest rate by 0.25 percent to 2.25 percent (the increase recently approved by the Federal Reserve Board) the amount would be $1,148,594.92 – a reduction of $33,021.71. And if you change only the interest rate 5.25 percent – roughly the historical average of money market accounts and ten-year certificate of deposits – the amount would be $838,029.90, a whopping reduction of $343,586.73.
Stay with me here. As interest rates rise, the amount of principal required to maintain a monthly pension payment reduces. The announcement for Federal Reserve Board increases the discount rate and indicates a path to continuing increases. That means that those seeking lump sum payments from their pension plans are incentivized to act now to maximize their lump sum payouts.
Perversely, it is a double whammy. By acting now, recipients can not only maximize their payouts but they can then take advantage of increasing interest rates of return by reinvesting their lump sum to increase the amount of money available to them on a monthly basis. But in doing so the total pension plan principal is reduced and that reduction means that there is less upon which to earn to make future pension payments. That is precisely the problem that the Dallas Police and Fire Pension System is experiencing in the article above.
Most public employee retirement systems at the city, county and state level have huge unfunded future liabilities. An August 7 editorial in the Eugene Register-Guard noted:
“Actuaries for the Public Employees Retirement System paint a grim picture of the next half-dozen years: State and local governments will have to increase their contributions to the pension system by an amount equal to about 4 percent of total payroll costs next year, and again in 2019, and again in 2021. Those increases will absorb most or all of the money otherwise available for pay raises for current employees, or for improved public services. PERS is squeezing everything, testing the Legislature’s ability to act.
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“Here’s another way to put it: Over the next two years, state and local governments will spend an additional $1.3 billion on everything that counts as payroll: teachers in the classroom, cops on the beat, nurses in the clinic, and for any raises or benefit enhancements these people receive. In that same period, those same governments will pay an additional $885 million to cover pension obligations. Of all the additional resources available to government during the next biennium, 41 percent will go to PERS.
“It gets worse: By 2021-23, governments’ aggregate PERS contributions will be $4.5 billion, more than double the $2 billion for the current two-year budget period.
“Even contributions at that level won’t be enough to cover the pension system’s unfunded liability of $21.8 billion. PERS currently has enough assets to cover only 71 percent of its future obligations. The shortfall must be made up by the system’s only two sources of funds — income from investments or the taxpayers.”
If state and local pension plans begin experiencing an increase in the number of people electing the lump sum payment, the amount of assets available to meet future demands is even less and the unfunded future liability will grow. The $21.8 Billion unfunded future liability for Oregon already exceeds the current general fund biennial budget and will only grow worse.
So here it is. The public employee unions will do all in their political power to stop any attempts to limit lump sum withdrawals – and in states like Oregon where they own the dominant Democrat Party that means they will succeed. You may suggest that by doing so they will jeopardize future payments to their members but they argue that state must meet its pension obligations regardless of what has transpired before.
So for taxpayers generally, and those in Oregon particularly, get you checkbooks out. Either your taxes are going to go up substantially, or your services, including education and police and fire protection, are going to go down substantially. It is a vexing problem and here is precisely what Gov. Kate Brown (D) and the Democrat majorities in Oregon’s legislature are going to do about it.