Unfunded Public Retirement Benefits

The NY Times has a fairly scary (though not particularly surprising) article about unfunded retirement obligations of government bodies.

Thousands of government bodies, including states, cities, towns, school
districts and water authorities, are in for the same kind of shock in the next
year or so. For years, governments have been promising generous medical benefits
to millions of schoolteachers, firefighters and other employees when they
retire, yet experts say that virtually none of these governments have kept track
of the mounting price tag. The usual practice is to budget for health care a
year at a time, and to leave the rest for the future.

Off the government balance sheets - out of sight and out of mind - those
obligations have been ballooning as health care costs have spiraled and as the
baby-boom generation has approached retirement. And now the accounting rulemaker
for the public sector, the Governmental Accounting Standards Board, says it is
time for every government to do what Duluth has done: to come to grips with the
total value of its promises, and to report it to their taxpayers and
bondholders.

Its not too surprising to most of us that the government, which is actively putting Enron managers in jail for hiding liabilities off-balance-sheet, turns out to be a far worse offender at the same practice.  The few agencies that have performed the actuarial calculation are coming up with staggering numbers:

Stephen T. McElhaney, an actuary and principal at Mercer Human Resources, a
benefits consulting firm that advises states and local governments, estimated
that the national total could be $1 trillion. "This is a huge liability," said
Jan Lazar, an independent benefits consultant in Lansing, Mich. "If anybody
understands it, they'll freak out."...

Maryland, for example, now spends about $311 million annually on retiree health
premiums. But when that state calculated the value of the retirement benefits it
has promised to current employees, the total was $20.4 billion. And the yearly
cost will jump to $1.9 billion under the new rule, according to an analysis for
the state by actuaries at Aon
Consulting, which advises companies on benefits.

I usually severely discount consultant scare numbers like "$1 trillion", particularly after the year 2000 bug orgy of doomsaying, but if Maryland, an average size state, is facing $20 billion, then a trillion may only account for state governments.  The number may well be higher when you include cities, counties, school districts, etc. 

While this is clearly bad news, there is also a silver lining.  Politicians for years have given away richer and richer public employee retirement benefits because they appeared "free"  (free to a politician being anything that doesn't have to be paid for when he/she is in office).  By changing accounting standards to force acknowledgment of this liability, politicos will at least have to address true costs of any future giveaways.

As a minimum, most public authorities are looking to change benefits for new employees, which is an entirely reasonable response that should have been taken years ago.  Just as past changes in public accounting for pensions caused agencies to shift benefits to 401K's from defined benefit pensions, so this rule-changes in retiree medical care will certainly change benefits packages.

However, that being said, I have a much bigger problem with several state's proposals to retroactively reduce benefits for existing retirees and employees.  These retirement benefits are a contract, and should not be allowed to be changed casually, any more than could an agency just choose to renege on a municipal bond payment.  Sure, the commitments may have been irresponsible, but that does not make them automatically void.  Private companies from time to time get themselves in a similar mess, and the only way for them to relieve themselves of some of this liability is through the bankruptcy process.  Public agencies should be forced to do the same.  They should not be able to use their coercive legislative power to just make these obligations disappear at the stroke of a pen -- they need to go through the pain of a bankruptcy, where all creditors, not just pensioners selectively, will need to share in the haircut.

  • http://www.linesinthesand.net Doug Murray

    Would such rule changes be made to apply in Washington as well? That could change Social Security discussions significantly.

    For example, one of the favorite arguments against personal/private accounts is the cost of borrowing needed for the conversion. That borrowing is actually a timing difference that just transfers the off book obligation to the balance sheet earlier than planned. This rule would force booking the entire existing debt and reveal the true cost of conversion borrowing to be much lower than claimed.

  • Todd K. Moyer

    Interesting that this is happening nationwide. Oregon already went through this a few years ago. During the stock market bubble, public retirement packages were so fat that people were retiring with pensions greater than their salaries. Turns out they had pensions that were allowed to grow with no limit to the upside, and the downside was limited to an annual 8% rate of return on the invested funds. That is great, as long as market returns exceed 8%, if you're a retiree. But, the fund was not benefiting from the excess returns; they were delivered to retirees. That means no cushion when the market produced FAR less than a +8% return for several years. Not so great for taxpayers who have to make up the difference. It quickly balooned into a huge liability.

    Who thinks up this stuff? Who was dreaming that they could guarantee a MINIMUM 8% annual return? I'm thinking somebody who didn't figure it was coming out of his pocket...

  • http://www.theglitteringeye.com Dave Schuler

    It's unlikely that Illinois public employees will go to a defined benefits plan. Here the inviolability of public employees pension plans has constitutional force. That makes the underfunding of public employees pension funds all the more an outrage here.