Reforming Public Pensions
September 17, 2015
Public pension funds are in need of serious reform. Multi-trillion dollar unfunded liabilities and exorbitant fund management costs threaten to bankrupt multiple local governments. Some cities, such as Detroit, Michigan, and Stockton, California, have entered bankruptcy, and pension costs played a role in each case.
Defenders of public pensions say that the industry has made a comeback from the Great Recession. But analysts say claims of the public pension industry's comeback are greatly exaggerated. Most plan sponsors have failed to make their minimum actuarially calculated requirements and the percentage of sponsors making full contributions continues to decline.
- In 2013, only 41% of plans received their full annual required contribution (ARC).
- The Government Accounting Standards Board (GASB) allows plan managers to value pension funds using the rate of return for high-risk portfolios implying a greater return than is likely, thus increasing government exposure to unfunded liabilities.
- If we discount public plan benefits using a corporate bond yield, as private pensions are required to do, public pensions nationwide are on average only about 46 percent funded, and unfunded liabilities top $2.6 trillion.
GASB rules encourage risky investments because, ultimately, it is the government that will be forced to pay a plan's promised benefits in the event that the fund fails to meet expectations. As a result, U.S. public plans hold more risky assets than do corporate pensions. GASB rules also create an incentive for public plans to exaggerate the returns on their investment portfolios. Public plan investment assumptions are substantially higher than the projections made by investment consultants who advise the plans.
Policymakers and elected officials must begin to reform public pensions in order to bring expectations and reality back in-line. Reforms must target the perverse incentives created by GASB rules that discount fund-management costs, encourage risky investments and permit over-promising projected returns to pensioners.
Source: Andrew G. Biggs, "The State of Public Pension Funding," American Enterprise Institute, September 2015.
Browse more articles on Government Issues