In a recent Wall Street Journal op-ed, Andrew Biggs of the American Enterprise Institute neatly summarized the problems inherent in public employee pension plans such as our own PERA.
The article (http://www.aei.org/article/101814) pointed out that the actuarial assumptions embedded in the projected funded ratios of these multi-billion dollar structures, which are meant to have sufficient assets to pay retirees the generous benefits that they were promised, are as phony as three-dollar bills.
To be fully funded, and to be able to meet all of its projected pension obligations, PERA is counting upon 8 percent annual returns during the next 25 years.That’s highly unlikely, says Biggs, who discusses the difference between an assured rate of return and a hypothetical rate.
“Imagine that you borrowed $100,” Biggs wrote, “which you absolutely, positively must repay in 20 years. How much money would you need today to consider that debt “fully funded?”
The problem is fundamental: According to accounting rules adopted by the states, a public sector pension plan may call itself “fully funded” even if there is a better-than-even chance it will be unable to meet its obligations. Here are two correct answers, followed by an incorrect one. All three rely on “discounting,” a method of calculating the sum of money needed today to fund a given liability in the future.
First, discount $100 at the 4.5% yield on safe, 20-year Treasury notes. This produces a present value of $41.46, which you invest in Treasury securities. Barring federal government bankruptcy, you can repay your debt with certainty.
Second, discount $100 at the expected return on stocks – say 8 percent. This produces a present value of $21.45, which you invest in equities. Next, purchase a “put option” giving you the right to sell your portfolio 20 years hence for no less than $100. This option would cost $20.08, for a total cost today of $41.53. Barring the collapse of the options exchange, you also can be certain of repaying your debt.
But here is a third answer: discount $100 at an 8 percent interest rate. Invest $21.45 in stocks. Declare yourself “fully funded.” This doesn’t work because there’s a very good chance your risky assets won’t appreciate in value enough to cover the debt. Yet this is how public sector pension accounting operates.”
This may seem like arcane stuff, but it’s not. Even with the legislature’s recent PERA fix (the second such fix in the last five years), the plan still relies upon 8 percent returns. Read what Biggs has to say about state pension plans, which in his estimation constitute an unrecognized, unacknowledged $3 trillion debt burdening virtually every state in the nation. Then ask yourself a simple question: is it more likely that PERA will realize its expected returns, or that at some future time (5, 10, 15 years from now) the taxpayers will have to rescue the plan from insolvency.
As for me, I’m hoping for 8, 10, even 12 percent. That’d allow my own meager portfolio to appreciate enough so that we could buy that condo is Scottsdale in a few years … of course, I wouldn’t have the benefit of PERA’s professional portfolio management, so maybe I should settle for a timeshare.