For state and local governments facing budget crises, public employee pensions are a top concern. Years of politicians promising generous benefits to their public employee union supporters have left their successors with obligations which they are struggling to pay.
This is widely acknowledged as a serious problem, but the level of underfunding has been a matter of debate, largely because of disagreement over accounting methods.
Pension funds’ own official estimates are based on criteria set by the Government Accounting Standards Board (GASB), which allows funds to set a discount rate to estimate the funding they will need to pay future obligations based on returns they expect to receive on investment.
Many funds set the discount rate at around 8 percent, which has been — rightly — criticized as too high. While pension funds can earn that on average over several years, they can fall short in some years. Meanwhile, obligations continue going up every year, and taxpayers are exposed to filling in the funding gap.
Two new reports, by the Pew Center on the States and the Congressional Budget Office (CBO), acknowledge that problem, and note that previous underfunding estimates may be on the low end.
The Pew report says that state employee pension funds are underfunded by at least $1.26 trillion. However:
The CBO also acknowledges this controversy, and cites significantly greater underfunding estimates, based on lower discount rates derived from fair market value, an alternative method to the GASB one. CBO defines fair market value as ” what a private insurance company operating in a competitive market would charge to assume responsibility for those obligations.” This would carry a lower discount rate. (CBO cites studies by Alicia Munnell and by Robert Novy-Marx and Joshua Rauh.)
At Openmarket.org, I discuss in greater detail the Pew and CBO reports and the debate over pension accounting methods.
