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Public Sector Pensions: Is it a Crisis?

This article discusses the unfunded liability crisis in public sector pensions, with estimated liabilities of $3 trillion and several states projected to run out of assets by 2020. It explores the discount rate debate, contribution deferrals, and the need for reforms to shift the risk away from taxpayers and stabilize retirement plans for public employees.

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Public Sector Pensions: Is it a Crisis?

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  1. Public Sector Pensions: Is it a Crisis? Eileen Norcross Sr. Research Fellow, State and Local Policy Project Mercatus Center at George Mason University April 1, 2011

  2. The Magnitude of the Problem Unfunded Liability officially reported at $438 billion Closer to $3 trillion Several states estimated to run out of assets to pay liabilities by 2020

  3. How Did It Get to This Point? Discount Rate Assumption and Investment Behaviors Enhancing Benefit Formulas Contribution Deferrals. In the past 5 years, 21 states failed to make their full payment

  4. What is the discount rate debate?

  5. What Actuarial/GASB standard implies Public pensions can be guaranteed with risky investments Uncertain investments are treated as certain Encourages plans to accept more risk Lowers today’s contribution Leaves taxpayers exposed to the risk that returns are not met

  6. ARC versus the Employer Contribution Pension Deferrals have been undertaken since 1992

  7. What economists’ approach implies Value of liability is independent from how assets are invested. Liability valued to reflect the certainty of payment; Investment strategy is a separate question Does not imply that the portfolio must be solely in bonds Also, if government stated there was a risk – then it would warrant a higher discount rate

  8. What’s the scope of the problem Several states in poor shape and this matters They will need to increase their annual contributions by four-fold (3 to 13 percent) in New Jersey and Illinois Not every state runs out – some in better shape. Several cities also face run-out dates by decade’s end.

  9. The challenge for budgets Systematic misvaluation and undercontributionsmean the need for greater current and future contributions Factor in cost pressures in Medicaid, health care reform act, health benefits, federal policy actions and a weak recovery.

  10. The government is long-lived Does this justify using the expected return on assets? No, to the contrary. The government is long-lived and that makes it more likely that it will not default and it will pay its pension obligations

  11. Risk goes away with time Claim: the government is a long-term investor and can ride it out Long-term investors don’t “get” the expected return – they get a random and uncertain draw from a wide distribution of possible realized returns – risk accumulates If cumulative return is below expectations – likelihood of failure increases

  12. What should be done? Start with the right valuation: distorted numbers lead to distorted decisions Stabilize these systems Shift the risk away from the taxpayer Design stable retirement plan for public employees

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