Planet Money
3:48 pm
Mon July 23, 2012

Why Public Pensions Are About To Look Less Healthy

Originally published on Tue July 24, 2012 5:26 pm

On Friday, Planet Money's Caitlin Kenney told Morning Edition listeners how public pension plans are going to look a lot less healthy very soon. A new study shows just how bad they might look, even as it offers some caveats to its own results.

Public pension systems, of course, are hurting in many states and cities. Some haven't been funded sufficiently to provide promised retirement benefits to teachers, firefighters or other public-sector workers. Poor investment returns have taken their toll across the board. Benefits are being curbed in some places because the costs of these pensions compete with other priorities like schools, parks, transportation and public safety.

The new problems come from the green eyeshade crowd — the Government Accounting Standards Board. Under new rules from the board, state and local governments will have to change how they present the financial health of their pension plans to the public. Although the changes are dramatic at first glance, there are some important caveats.

The overall picture is scary. Under the old rules, plans reported having, on average, 76 percent of the assets they would need to pay promised benefits to every retiree and employee from now until the last one dies.

The new rules would slash that figure dramatically — to an estimated 57 percent, according to a report from Boston College's Center for Retirement Research, which used 2010 data (the most recent broadly available). As the chart below shows, the impact of the change varies enormously. But bottom line: very few retirement systems would look healthier.

Pension administrators have taken issue with the Center's estimates. Matt Smith, the actuary from Washington State, says he disagrees with the report's projections for his state's pension funds. Smith says the study ignores recent benefit reductions, made some assumptions on only a few years' data, and doesn't use 2011 investment returns. He and his staff are currently preparing figures that he says will better reflect the impact of the accounting changes.

Now, these rules don't change by a penny how much money the plans have, or how much they must pay in benefits. They still have the same pools of investments to pay the same IOUs to retirees, on the same schedule.

What will be different is the picture that's presented of how plans are doing.

Today, public pension plans are allowed to smooth out the ups and downs of their investment returns. Losses from the financial crisis of 2008 aren't reflected in many plans, but neither are most gains from 2010, an up year in the stock market. The idea is that pension plans must look far into the future so short-term ups and downs are less important. At the same time this smoothing can mask serious problems for years.

The new rules would stop the smoothing. Instead, pension funds would have to show gains and losses each year. That could mean big swings in a plan's heath from year to year, especially for plans heavily invested in stocks, hedge funds or other unpredictable investments. In many ways, it's a more precise presentation. And for employees with pensions at stake, it may be a stomach churning one.

There are other changes. Many plans will have to be more conservative in setting the number they use to figure out what their pension IOUs are worth in today's terms — the discount rate (a concept covered in detail by our show Friday). That change, too, will make plans look more fragile.

The new rules are controversial, for both technical and public-policy reasons. The accounting standard-setters explicitly warn that the new rules aren't meant to be used to decide how much governments should contribute to their plans. But pension advocates worry that's just what will happen.

Plan administrators say the new rules also don't adequately take into account the fact that pension plans have decades to make good on their promises, meaning year-to-year fluctuations shouldn't play such a big role in the accounting.

Either way, the new numbers are likely to make an unpleasant splash for governments and their employees alike.

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