Passing on Our Debts

With this past year's stock market meltdown, state and local government retirement plans racked up a colossal funding deficit of $2.5 trillion, counting both pensions and retiree medical plans. That's $20,000 for every working adult in America. Most of those bills were shuffled off to future taxpayers rather than paid when the benefits were earned. The public pension shortfall is almost as big a problem as Social Security's baby-boom deficits.

The Governmental Accounting Standards Board (GASB) has launched a new study of pension accounting practices. Normally, this would put public officials to sleep, but the outcome of this study could have a major impact on pension finances and municipal budgets.

One key issue is the inter-generational question: Who should pay for the costs of retirement benefits already earned by public workers? Some governments have granted retroactive pension benefit increases to groups of employees and then strung out the cost for 30 years into the future. That practice saddles future generations with bills for past services from which those generations get no benefits.

Similarly, the amortization of unfunded retirement benefits, including retiree medical costs, is often delayed for 25 to 30 years under current accounting rules. On its face, this seems ridiculous. Public safety employees in many jurisdictions need only work for 20 years to earn a lifetime pension. If the $2.5 trillion accumulated deficits were spread over the average remaining service lives of the employees, the amortization period would be roughly half the prevailing averages--which would immediately raise pension costs.

As baby-boom workers near retirement, this issue becomes increasingly important--and fiscally problematic. It's like selling 30-year bonds to buy an obsolete street sweeper.

The inter-generational issue also plays a role in another calculation that GASB is looking at: the actuarial assumptions that pension trustees make about their investment returns. Presently, each retirement board determines its own assumed rate of return on investments to use in actuarial calculations. A higher earnings assumption permits a lower annual pension contribution. But when actual investment returns fall short of the assumptions, the higher bill is then delivered to future taxpayers. Some pension trustees adopted pie-in-the-sky investment assumptions, and their shortfalls in the recent market meltdown were horrendous. Several actuaries want GASB to adopt the solution of using much lower government bond yields as the basis. To me, that's overkill. The bear market already has knocked down these asset values.

The investment-returns topic will be hotly debated, but it seems curious that accountants would tell actuaries how to do their calculations--especially if the actuaries can't agree among themselves. Improved disclosure should be sufficient to inform investors and taxpayers.

The pension community wants GASB to leave the current accounting model alone and let governments spoon out their liabilities as they wish. My advice to GASB is to require inter-generationally correct measurements but phase in the implementation. Cash-strapped governments need to recover from the current recession before higher bills hit. Let's be accurate, but practical.