PUBLIC PENSION PRICE TAG
August 21, 2006
Because their size and complexity offer such a wide field for abuse, state and local retirement systems pose a significant moral hazard -- threatening the long-term fiscal stability of many of their sponsors, says E.J. McMahon, senior fellow at the Manhattan Institute.
In determining a system's necessary funding levels, methods vary greatly between private and public plans:
- Private plans are required to discount their liabilities based on corporate bonds, which are usually lower than these plans' projected returns on investments.
- Public funds, however, are allowed certain accounting twists, which discount their long-term liabilities based on the assumed annual rate of return on their assets -- which, for most public funds, is pegged at an optimistic 8 percent or more.
If the liabilities of public pension funds were valued on the same basis as private funds, funding requirements would be dramatically higher, says McMahon:
- Even "fully funded" systems like New York's would find themselves tens of billions of dollars in the hole.
- In total, estimates of the nation's real public pension funding shortfall range from an added $500 billion for state retirement systems to at least $1 trillion for all public systems.
Thus, the overriding concern of public pension reform should be to reduce the taxpayers' exposure to accounting and financial risk -- now and in the future. According to McMahon, four essential steps towards that goal include:
- Shift to defined contribution plans for all future workers.
- Immediately recognize and fund the full cost of any benefit increase.
- Expand financial reports to include alternative funding assumptions.
- Gradually lower the expected rate of return -- and invest accordingly.
Source: E.J. McMahon, "Public Pension Price Tag," Wall Street Journal, August 21, 2006
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