A round-up of scary public pension stories

by Grace

This collection of stories about the public pension problem should get the attention of taxpayers and government employees relying on future pension payouts.  (Of course, these two groups are not mutually exclusive.)

Next School Crisis for Chicago: Pension Fund Is Running Dry (New York Times)

Illinois on the hook for $670 million more in teacher pensions for next budget (Chicago Tribune)

‘Exploding pension costs are the single biggest threat to local government’s ability to deliver needed services’ (Cost of College)

From the No Pension Bailout website:

State pension systems across the nation are dramatically underfunded.  Reasons vary, but in most cases state governments have failed to allocate sufficient money to their retirement systems. additionally states granted overly generous benefits to workers without proper regard for the cost of these benefits.

Recent calculations estimate unfunded pension liabilities to total roughly $2.5 trillion – creating state budget crises nationwide.  States are being forced to slash budgets for education, healthcare, and public safety to make room for the spiraling costs of pensions.  Some states are working to fix the problem, but others are not, instead content to wait for federal bailout of state pensions.  A bailout would force states with the resolve to fix their problems to subsidize those that prefer handouts – destroying state’s fiscal sovereignty and creating one of the largest transfers of wealth in the history of our country.

A problem with accounting methods used by state governments

State pension systems across the country are in a state of crisis. According to the Pew Center on the States, states estimated their unfunded pension liabilities at $757 billion in 2010.  Most pension experts, however, take issue with the standard actuarial methods used by most public pension plans, which lets state governments hide billions of dollars in pension debt. Under more reasonable accounting standards, states’ pension debt grows to more than $2.5 trillion.

Inflated discount rates hide true taxpayer liability

Economists Robert Novy-Marx and Joshua Rauh, for example, challenge the unrealistic investment targets and discount rates used by public pension systems to adjust their liabilities into today’s dollars. They found that the median discount rate used by the largest pension systems in the U.S. was 8 percent. This means that the pension funds anticipate earning 8 percent annual investment returns. Pension experts believe high discount rates encourage states to invest their pension funds in riskier assets in order to justify using inappropriately high discount rates.  In effect, using high discount rates allows government pension plans to hide hundreds of billions of dollars in pension debt from taxpayers.

These inflated discount rates have become so unreasonable that both the Governmental Accounting Standards Board and Moody’s Investors Service issued new rules in 2012 that require state governments to use more realistic assumptions. These new rules require governments to use discount rates closer to the yields from corporate and municipal bonds, which will provide a clearer look of pension finances. In Illinois, the new reporting rules will more than double the state’s officially-reported pension debt.

In the private sector, a guaranteed benefit must use risk-free returns in calculating future liability.  But for public pensions, the taxpayers are expected to meet the huge gap between overly optimistic promises and the reality of low investment returns.

As most experts explain, public pension funds should use lower discount rates to reduce the investment risk to taxpayers. This typically means that the discount rate should be based on risk-free returns, such as Treasurys. These discount rates would reveal that between half and three-quarters of all public pension debt is hidden by accounting gimmicks. If government pension plans were subject to the same reporting rules as private pension plans, their reported pension debt would nearly triple.

Do the math:
Median discount rate used by largest public pension funds - 8%
Current 10-year US Treasuries rate – 1.6%

Progressives Sour on Chicago Teachers (Via Meadia)

…[T]he city of Chicago most certainly can run out of money. Things like extra money for music and art teachers could be great ideas or could be bad ones depending on where it comes from. But it’s not as if Chicago Public Schools is sitting on some giant pile of money that administrations have just been refusing to use. On the contrary, it’s actually sitting on a large unfunded pension obligation. . .

In our local school district, pension costs are soaring to make up for unreasonably optimistic pension promises.

… pension costs have risen more than 50% over the last two years and now account for 7.2% of the total budget, up from 5.1% in 2010-11.  This has meant ongoing cuts in student services as taxes are diverted to pay for pensions.  The trend is up, and by 2015 pension costs are expected to eat up 35 percent of property tax collections.

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5 Comments to “A round-up of scary public pension stories”

  1. I think prosecuting would be hard because it appears in most cases they’re working withing the system, as corrupt as it is. One that did go a little too far is Rod Blagojevich.

    The task force noted that Gov. Pat Quinn had inherited the insolvency from the previous governor, Rod R. Blagojevich, who is serving a prison sentence for corruption. The $10 billion pension obligation bond was issued on Mr. Blagojevich’s watch, and prosecutors said at his trial that he had used the transaction to raise campaign money in a pay-to-play scheme. The state paid a total $76.3 million in issuance fees, but the pension fund ended up worse off than ever, because bondholders were promised that the state would divert its pension contributions to pay their interest.
    http://www.nytimes.com/2012/10/25/business/illinois-debt-takes-toll-on-services-study-finds.html?ref=us&_r=0

    Part of the solution would be to change to defined contribution plans. In the case of teachers, this could actually benefit those teachers who want more flexibility in being able to move between school districts.
    http://www.empirecenter.org/AboutUS/news_releases/2012/03/dcpoll031412.cfm

  2. Defined benefit vs. defined contribution is not the problem—the problem is systematic long-term underfunding. With defined contribution, you know the current value, but have to guess at the future value. With defined benefit, you have to guess at both, since the benefit is defined only as long as the plan remains solvent.

  3. My point about defined contribution is that there is no generous guaranteed payout that would have to be supported by taxpayers. The risk is borne by the employees, the same as with most employees in the private sector. Of course, as Bonnie points out, individuals are also not very diligent about contributing to their retirement plans.

  4. Diligence in contribution is expected to be better with ‘opt-out’ policies rather than ‘opt-in’. I don’t recall if the change was required, or if we’ve just happened to experience it, but both of DH’s last two retirement plans have been ‘opt-out’. (That is, contributions are deducted from the paycheck at a given level unless you specifically request otherwise. The level of contribution ramped up to the maximum allowed, if you weren’t already there, by increasing some percentage per year.) I haven’t seen any data on whether or not employees actually do contribute more to their retirement plans as a result.

    Of course, there’s still the problem of managing the account.

  5. The “opt-out” requirement was made easier for employers to implement by changes in the 2006 federal pension legislation. I believe it has been shown to increase participation.

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