State pen­sions in the red

Public em­ployee re­tire­ment sys­tem cri­sis con­tin­ues to worsen

The Washington Times Daily - - Opinion -

New York is the lat­est state strug­gling to bail out its over­grown public pen­sion sys­tem. Like the re­tire­ment pro­grams of other state and lo­cal gov­ern­ments na­tion­wide, the Em­pire State’s pro­gram is in the red, and it’s look­ing for $750 mil­lion in loans this year. What’s wor­ri­some is that un­til just a few years ago, New York pen­sions were con­sid­ered ad­e­quately funded.

The story re­peats it­self from coast to coast. Gov­ern­ment re­tire­ment pro­grams of­fer overly lav­ish prom­ises backed by in­ad­e­quate con­tri­bu­tions and a lack of trans­parency. New York’s gim­mick to get through this year is to of­fer re­duced con­tri­bu­tions to­day in ex­change for prom­ises of higher pay­ments in the fu­ture. The prob­lem with this ap­proach is that the public em­ploy­ers, the state and lo­cal gov­ern­ments, are bor­row­ing from the state’s own pen­sion sys­tem so they can fi­nance their con­tri­bu­tions to the sys­tem. It’s noth­ing more than an ac­count­ing trick: No ac­tual money goes in, but pen­sions still have to be paid out. The re­sult is a pen­sion sys­tem with less fund­ing than be­fore.

It’s easy to blame the dire pen­sion sit­u­a­tion on the bank­ing cri­sis, the re­cent re­ces­sion and the ane­mic re­cov­ery, but some state pen­sion plans were in trou­ble and con­sid­ered in­ad­e­quately funded even be­fore 2001. That’s what Cato In­sti­tute re­searcher Ja­gadeesh Gokhale con­cluded in a re­port re­leased last week. De­spite the hous­ing and eq­uity boom that oc­curred be­tween 2004 and 2006, the share of pen­sion plans that were con­sid­ered in­ad­e­quately or poorly funded con­tin­ued to grow steadily through 2009 (with the ex­cep­tion of 2007). Us­ing the fair mar­ket value of as­sets of the port­fo­lio as the stan­dard, about one-half of state and lo­cal pen­sion plans had fallen be­low the crit­i­cal 60 per­cent fund­ing level by 2009.

The red ink wasn’t just caused by the mar­ket crash. The num­bers ac­tu­ally might un­der­state the ex­tent of un­der­fund­ing. The Gen­eral Ac­count­ing Stan­dards Board (GASB) re­quires the pen­sion plans to dis­count fu­ture pay­outs at the same rate as the rate of re­turn on the in­vest­ments that will be used to pay the ben­e­fits. Pen­sion plans in­vest in all kinds of risky as­sets with fluc­tu­at­ing re­turns. They typ­i­cally use in­vest­ment re­turns of 8 per­cent or more as the dis­count rate.

This is highly prob­lem­atic. First, the Dow Jones in­dus­trial av­er­age grew at the rate of 5.3 per­cent over the 20th cen­tury and shows no sign of ex­ceed­ing 8 per­cent this cen­tury. Sec­ond, pen­sion-fund li­a­bil­i­ties usu­ally are con­sti­tu­tion­ally guar­an­teed, which means states al­most cer­tainly will not de­fault. The ap­pro­pri­ate dis­count rate on these, then, is, as Mr. Gokhale says, closer to that on U.S. Trea­suries. That rate cur­rently is vir­tu­ally zero.

These pro­grams sim­ply cost too much. Eighty-four per­cent of state and lo­cal em­ploy­ees have ac­cess to a de­fined-ben­e­fits plan, com­pared to just 20 per­cent in the pri­vate sec­tor. That’s bad be­cause the pay­outs for public em­ploy­ees are about three times higher than what pri­vate-sec­tor work­ers re­ceive. States aren’t go­ing to re­pair their economies with­out deal­ing with this im­bal­ance in a se­ri­ous way, with­out the smoke and mir­rors.

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