Warren Buffett was at his prophetic best when he wrote in Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s 2013 Annual Report:
“Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford. Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them. Unfortunately, pension mathematics today remain a mystery to most Americans… During the next decade, you will read a lot of news – bad news – about public pension plans.”
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Underfunded pension and retirement liabilities have already reared their heads in Los Angeles, which in early 2013 appointed a committee of eminent city personalities chaired by former US Commerce Secretary Mickey Cantor to study and report on fiscal stability and job growth in Los Angeles.
LA 2020: Challenges faced by the city
The Los Angeles 2020 Commission (LA 2020) published its assessment of the challenges and opportunities the city faces in its first report, A Time for Truth, in January 2014. One of these challenges was:
Wishful thinking and avoidance of hard choices have endangered the secure retirements promised our public employees. Today’s workers are paying into a system whose benefits they’re increasingly unlikely to see. The City’s retirement system has seen the amount of money saved to fund the retirement of active City workers drop from 50% of the money needed to pay for their retirement to less than 10%…Pension costs accounted for 3% of the City’s budget a decade ago, and 18% this year. The cost of covering further increases will continue to cut into the City’s ability to supply services.
LA 2020 suggest measures renew job creation
The Commission has followed up its first report with another, A Time for Action, issued yesterday, which suggests measures to renew job creation in Los Angeles, improve fiscal stability and enhance transparency and accountability in its municipal operations.
Amongst the many suggestions put forward, including the combination of L.A.’s two harbors into a single port, increasing the minimum wage, and promoting tourism, there was one for closing the gap in L.A.’s retirement liabilities and available funds.
The LA 2020 commission suggested that the discount rate of 7.75% used to determine the present value of L.A.’s future retirement payouts was “at the high end of the range which makes future obligations seem smaller, and raises the question whether is sufficient savings are being put away today.”
The LA 2020 commission suggested that Los Angeles adopt a new “Buffett Rule” that would model funding of the city’s future promises after Warren Buffett’s Berkshire Hathaway, which uses a discount rate of only 4.0%.
However, according to Reuters, the city of Los Angeles owes nearly $10 billion in unfunded pension and retirement liabilities and is unable to balance its budget – next year the budgetary deficit could touch $240 million.
In such a situation, contributing an additional $560 million a year, which is the implication of adopting the Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) discount rate, may not be feasible.