March 18, 2013
I am somewhat ashamed to admit I envy my mother because she does not have to work anymore. But I also have my fingers crossed on her account. As a retired social worker, she manages to pay her bills with her state pension. And I know that her retirement rests on a shaky foundation.
Few Missourians lie awake at night worrying about shortfalls in the state pension system. But the fact is, taxpayers are on the hook if these pensions fail to deliver. That has the potential to cost you and me (and millions of other Missourians) billions. So maybe it is worthwhile to have a better understanding of what is going on here.
It is bad enough that combined unfunded liability of the state’s five largest public pensions comes to $11.1 billion.
But that is just the official number for the unfunded liability (the value of liabilities in excess of assets). A recent policy study written for the Show-Me Institute explains how the official number is far too low. The author of the study, Andrew G. Biggs, of the American Enterprise Institute, finds that the real value of unfunded pension liabilities is close to $54 billion — which is nearly $9,000 for every man, woman and child in Missouri.
Biggs’ numbers differ so dramatically because of differences in the so-called “discount rate” used to value pensions’ future benefit liabilities. For example, if I owed someone $10,000 a decade from now, how much money would I need to invest today in order to make that payment? Assuming I could get a robust 12 percent annual return on my money, I would need to invest only $3,200 now in order to repay my loan. However, on the more conservative estimate that I would only get an annual 4 percent return on my money, I would need to invest $6,800.
Therein lies the rub. Under rules the Governmental Accounting Standards Board establishes, public pension plans are allowed to discount their liabilities based on the assumption of earning consistently high rates of return (in Missouri, from 7.25 to 8 percent). The problem is, these discount rates are based on risky investments in stocks, while the benefits that Missouri pensions promise are anything but risky: in fact, they are guaranteed by law. If pensions fail to receive their expected high rates of return, you will have to cover the shortfall. That is a “contingent liability” that current pension accounting rules simply ignore.
There is nearly universal support among economists for using low discount rates to value public pension liabilities. In October 2012, 98 percent of a group of elite economists surveyed by the University of Chicago’s Booth School of Business agreed that the discount rates that public pensions use are too high. Biggs cites other research, from the Congressional Budget Office, the Federal Reserve, academic economists and others, all pointing to the same conclusion: the high discount rates that Missouri pensions use substantially underestimate the true value of these plans’ benefit liabilities and overstate their funding health.
The main consequence of a lower discount rate is that more money should be set aside today to fully fund tomorrow’s benefits. With revenues as tight as they are, the prospect of funneling more money into public employee pensions is attractive to policymakers. Yet, with the livelihoods of so many, my mother included, depending on these pensions, it is necessary to make the difficult decisions needed to ensure these pensions are financially sustainable.
If that does not happen, something has to give: either taxpayers will suffer a big hit (i.e., more taxes), or there will be significant cuts in services, to the detriment of people all over the state, including my mother.