Tuesday, March 08, 2011

State Pensions Probably Worse Than Everyone Thinks

Reason Magazine's Veronique de Rugy takes a look at just how bad state pension mismanagement or more accurately mis-reporting might be.
For decades state officials have encouraged adults to believe in the financial equivalent of the Tooth Fairy: that state pensions can yield high returns while being risk-free. Now taxpayers are in for a serious toothache.

Nearly every state offers defined-benefit pension plans for public employees. Financed through a mix of employee and employer contributions along with the investment returns on pension funds, a defined-benefit plan represents a contractual obligation to dole out a set amount in annual payments for as long as the recipient lives, regardless of whether there are sufficient assets in the fund at the time of the employee’s retirement.

One would think this obligation to pay no matter what would have led states to invest conservatively and plan ahead. Instead, they have been following accounting rules that pretty much guarantee the funds will be unsustainable.

First, by law, states are not required to pony up regular contributions to pension systems. Lawmakers generally jump on any opportunity to be fiscally irresponsible, so many states have deferred pension payments and used their share of the contribution to increase spending in other areas.
Yes you read that right--by law the state--that is the employer of state workers--have not had to pay their portion of the pension contribution. They have been able to, and regularly do, defer making the payments in order to fund other projects. The result is that the amount of money available to make investments to get a return is not there--so the return is not as much.

States have an unrealistic vision of a rate of return--8 percent. So using that number (as unrealistic as it is), if there is $100 million in the coffers, 8 percent is $8 million. But if the state hasn't put their share into the coffers--then that $100 million might be significantly less. Over time that underfunding actually results in drastically less in terms of return.

De Rugy also points out that public pension accounting rules and private pension accounting rules are very different, resulting in very different outcomes.

But make no mistake--public pensions are screwed up and the ultimate victims are going to be the taxpayer.

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