Severity of Nation's Public Pension Crisis in Question

(March 7, 2011) — A report published last month by the Center for Economic and Policy Research has asserted that the plunge of the stock market in the years 2007-2009 is largely to blame for the nation’s massive pension shortfall.

While the report does not refute cases of pensions that were underfunded even before the market’s collapse, it states that prior years of underfunding is not the main reason that pensions face troubles now. “Much of the shortfall has been erased, yet the crisis is still the biggest part of the story as opposed to simply pension funds’ irresponsibility,” Dean Baker, author of the report, told aiCIO.

Another major takeaway from the report is the misconception about the proper discount rate used when calculating large shortfalls of public pensions, according to Baker, who argued that the conventional risk-free Treasury rate to assess liabilities “doesn’t make sense.” With funds highly invested in equities, he noted that funds should assume a higher rate of return. “Shortfalls in public pensions have been greatly exaggerated, and they haven’t been examined within the appropriate context,” Baker continued, referring to his claim that pension shortfalls are rarely analyzed relative to the size of the economy over the next 30 or so years. “I would urge chief investment officers to be mindful of how high the market is when they project future returns.”

When asked about Mayor Michael Bloomberg’s efforts to overhaul New York City’s pensions, Becker replied that political efforts to improve the nation’s pension systems have been fear-driven. “Undoubtedly, pensions are rife with abuse. That should be fixed. States aren’t taking advantage of offering defined-benefit pensions at little to no cost, which seems foolish. But, in most cases, the pension picture isn’t as bad as it looks.”

Baker’s comments contrast with a study last year from the Pew Center on the States that showed many states face a $1 trillion gap for public pension retiree health and non-pension retirement benefits. “While the economic crisis and drop in investments helped create it, the trillion dollar gap is primarily the result of states’ inability to save for the future and manage the costs of their public sector retirement benefits,” said Susan Urahn, managing director of the Washington-based policy research organization, in a news release. “The growing bill coming due to states could have significant consequences for taxpayers — higher taxes, less money for public services and lower state bond ratings. States need to start exploring reforms.”

According to Pew’s report, the pension deficit will have to be paid over the next 30 years by state and local governments, amounting to more that $8,800 for each household in the US. Figures are detailed in Pew’s “The Trillion Dollar Gap” report.

Pew’s study revealed the $1 trillion gap reflects states’ policy choices and lack of discipline for:

• failing to make annual payments for pension systems at the levels recommended by their own actuaries;
• expanding benefits and offering cost-of-living increases without fully considering their long-term price tag or determining how to pay for them; and
• providing retiree health care without adequately funding it.