Report: Pensions Use Accounting Tricks to Keep Up Appearances

Pension administrators are making their plan’s financial condition look better than it really is by perpetually putting off payments, according to a new report out of North Carolina State University.

The report evaluated data from 106 state pension plans located across all 50 states for the years 2001 through 2014. It investigated how state-funded pension plans respond to increases in liability, and increases in “normal costs,” which are defined by the report as costs a state incurs each year related to its projected pension obligations.

When these costs increase, “administrators tend to use less prudent methods that defer, or keep low, the pension contributions required from the state,” said the report, “while simultaneously, and perversely, improving the appearance of the plan’s funded status and the state’s funding discipline.”

The report compared plan administrators to someone who had a 30-year mortgage on a house, and instead of making mortgage payments each year, they simply re-amortize the remaining liability over a new 30-year period, every year.

“Using this approach, you can manufacture lower amortization payments for yourself, but you will not eliminate the underlying liability,” said Jeff Diebold, an assistant professor of public policy at North Carolina State University, and lead author of the report, in a statement.  “That’s called open-ended amortization, and despite being an unscrupulous accounting practice, it is widespread among state pension plans.”

According to the report, state officials can adopt open-ended amortization to reduce the amount the state must contribute to the pension system each year, or to improve the appearance of the state’s current funding effort.

“Regardless of the reason, open-ended amortization exacerbates funding shortfalls, compounding the risk that the state will have insufficient funds to pay its pension obligations to retired state employees,” said Diebold. “Worse still, we find that officials are most likely to adopt open-ended amortization periods when their plan’s financial condition worsens, and would otherwise require higher contributions from the state.”

The report said that nearly every state carries some public pension liability, and that more than half of the pension plans it evaluated have used open-ended amortization to address their liabilities.

Regarding increases in normal costs, such as statewide salary increases, the report found that many pension managers “adopt imprudent financial administration techniques” that effectively defer paying off liabilities while also making the asset-to-liability ratio appear healthy.

“This isn’t even a gamble, this is just a losing game in the long term,” Diebold said. “All but two states are legally required to meet their pension obligations, and at some point those bills are going to come due.”

One of the key reasons many states have low funded ratios is that they fail to make their annual required contribution, said the report, which cited a 2015 Pew Charitable Trust survey that found that only 14 states paid 100% of their annual required contribution, and that the average funding ratio among all 50 states was 80%.

“Worse still,” said the report, “estimates of funded ratios likely overstate the current financial condition of pension systems as well as the funding effort of states.

It also said the widespread use of “overly optimistic and overly generous” assumptions implies most states are now under-contributing.

“Generally speaking,” said the report, “the funding effort by states is insufficient to ensure that their pension systems are able to cover future benefit obligations.”