Byron Schlomach

Government Pension Funds: In Worse Shape Than They Admit

Posted on October 04, 2012 | Author: Byron Schlomach
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There has been much dispute lately over how well-funded public employee pension systems are. The debate derives, in part, from how we define “funded”.

Employees and employers contribute to pension funds, and those contributions are invested in stocks, bonds, real estate and other investment vehicles. These assets help finance current and future pension benefits. Pensions are considered almost rock-solid promises, so the contributions and investment earnings need to be enough to cover the benefit payments owed to current and future retirees.

Actuaries evaluate current and future retirees’ pension costs 30 years into the future. They make assumptions about how long pensioners will live and take account of current retirees’ pensions and the pensions of current employees if they retired immediately. Then, they calculate a single number for current liabilities. That number is the amount that ought to be in the bank to fully pay the pensions.

For this calculation, actuaries assume a rate of return on all the money invested. The assumed rate of return, or “discount rate”, makes a big difference in how big current liabilities might be. For example, if you invested enough now to pay back a $100 debt in 10 years and you expected a rate of return of 5 percent each year, you would need to invest $61.39. But, if you expected an 8 percent return each year, you would only need to invest $46.32 today.

Arizona’s government pension funds use a discount rate of either 8 or 8.25 percent, considerably higher than the 5 percent they have actually earned over the last decade. Consequently, while Arizona’s unfunded pension liabilities are officially $16 billion, a huge sum, the unfunded liabilities using the actual rate of return of 5 percent are more like $37 billion. That’s $5,800 for every man, woman, and child in the state.

We are being misled about the health of our pension systems but the legisalture could put a stop to that by requiring a lower discount rate be used to calculate funded levels. If pension funds expect taxpayers to pick up the tab, the least they can do is be straight-forward about the bill we’re facing.

Learn More:

Goldwater Institute: $50 Billion Tidal Wave: How Unfunded Pensions Could Overwhelm Arizona Taxpayers

Harvard Kennedy School: Underfunded Public Pensions in the United States: The Size of the Problem, the Obstacles to Reform and the Path Forward

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