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A cash flow perspective on public retirement funds [ClearOnMoney]
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A cash flow perspective on public retirement funds

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Commentary

A cash flow perspective on public retirement funds

29 Sep 2010 by Jim Fickett.

Cash flows of public pension funds were, in aggregate and on average, healthy over the period 1993-2008. However (1) some funds are less well funded than others and are now dipping heavily into capital, and (2) payments from funds grew at a 9% compound annual rate over 1993-2008, reinforcing worries about long-term solvency.

Most analysis of pension funds revolves around the full long-term picture, balancing the net present value of future obligations against current savings. But it is also natural to ask whether funds are doing all right in the short term, and here a cash flow analysis is interesting. Two weeks ago Bloomberg had an article with a bit more of a cash flow perspective:

Benefits paid by the 100 largest public pensions in the five years that ended June 30 grew an average of 8 percent annually, calculations based on U.S. Census Bureau reports show. In that period, the median annualized investment return was about 3 percent for public funds with more than $5 billion of assets, said an August report from Wilshire Associates, an investment adviser in Santa Monica, California. …

Funds in at least eight states that reported investment results for the fiscal year still spent more than 10 percent of their assets on benefits, Bloomberg data show.

Asset Outflow

“The fact such a large portion of assets is flowing out each year really challenges the longevity of these funds,” said Joshua Rauh, who teaches finance at Northwestern University in Evanston, Illinois. He projected retirement accounts in his and other states would run out of money within a decade. “It will be a crash landing,” he said.

The rising share of assets consumed by benefits is “interesting” but misleading, said Keith Brainard, research director of the Baton Rouge, Louisiana-based National Association of State Retirement Administrators. He pointed to the offsetting effect of annual payments into funds made by workers and state governments.

“Employer contributions tend to fluctuate, but employee contributions are remarkably steady,” he said.

From 1998 to 2008, the most recent full statistics from the Census Bureau, state and local government payments into retirement funds almost doubled to $82 billion. Over the period, worker contributions rose 70 percent to $37 billion.

130 Percent

During the same decade, however, benefits paid increased by 130 percent to $175 billion. Payments from the 100 largest public funds grew by another 9 percent during the first three quarters of the 2010 fiscal year compared to the first three quarters of 2009, according to the census.

From this it is a little unclear whether the problem is with a few funds or the aggregate, and whether the problem is only in the long term or also in the short term.

Census has historical summaries of the cash flows (and much else) of state and local government employee retirement systems, with annual data from 1993 to 2008.

From this a few things are clear:

  • Payments grew steadily and more rapidly than inflation and population – over this 15 year period, growth was about 9% per year
  • Investment returns were most of receipts, but varied wildly, while contributions were fairly steady; this illustrates very clearly the tension in the arguments over assumed future investment returns
  • Total receipts, while highly variable, were sufficient, in the aggregate, to cover payments over this period

One other point on short-term cash flows: For 2008, government and employee contributions were $119 billion, and total payments were $194 billion, so $75 billion, in return on investments, would have been adequate from a 2008 cash flow point of view. On $3190 billion in investable assets, that would have required only a 2.3% return. In other words, the high returns retirement plans are aiming for are in order to solve the long-term problem, not to cover short-term cash flows.