A new rule currently being considered by the Actuarial Standards Board would finally require public pensions to meaningfully account for risk. In a commentary for the Voice of San Diego, I explain how this would benefit all stakeholders.
Future Taxpayers and Public Employees Are Paying for Past Pension Mistakes
As San Diego County sues its own pension fund for the right to slash benefits for new hires, and while taxpayer costs continue their ascent to record-high levels, understanding the true cause of the county’s pension crisis is more important than ever.
While some blame the stock market crash of 2008-09, the real culprit was an explosive growth in the size of promised pension benefits, and the flawed accounting practices that encouraged such recklessness.
Over the past 30 years, the accrued liabilities of the San Diego County pension fund, SDCERA, increased by nearly 1,300 percent — almost four times more than the growth in the county’s total personal income over that same time period.
The willingness to make such large pension promises stems from accounting practices that understate their cost by ignoring risk entirely.
Specifically, by treating assumed future stock market returns as certain — despite acknowledging their investments will underperform expectations roughly 50 percent of the time — SDCERA can “discount,” or minimize, the estimated cost associated with safely funded employees’ future pension benefits.
Of course, ignoring risk on your balance sheet doesn’t make it go away in the real world, which is why this approach is outlawed in the private sector and rejected by public pension plans in more than 100 countries worldwide, with U.S. state and local public pension plans being the only exception from that consensus.
This also reveals why blaming San Diego County’s soaring pension costs on the Great Recession is so misleading. The cost was created when the promises were made, as indicated by SDCERA’s nearly 1,300 percent increase in accrued liabilities, not when they were exposed by a market downturn.
But because defraying costs to future generations is so politically attractive, there has been little interest in reform, despite the urgings of those like Warren Buffet, Nobel Laureate William F. Sharpe and what seems like the entirety of the economics profession.
Thankfully, after years of fierce criticism by prominent actuaries worried about the harm that would befall their profession as a result of its continued silence, the Actuarial Standards Board proposed a new rule that would finally require pension plans to meaningfully account for risk.
While the proposal would simply require plans to disclose the level of risk associated with their funding strategy, government unions are nonetheless howling in displeasure at the idea, terrified at the consequences of making the full cost of their pensions known.
But this reflexive opposition to honest accounting is short-sighted and destructive. As the experience of San Diego County so aptly demonstrates, the damage caused by overpromising is often borne by government workers themselves, particularly future hires.
After having been lulled into a false sense of security by numbers that overstated the health of the fund while understating the cost of increasing benefits, the County Board of Supervisors in 2002 passed a 50 percent benefit enhancement for all county employees.
But when the inevitable market downturn hit — a certainty for any long-term investor like SDCERA — paying the full cost of the 2002 enhancement fell to today’s taxpayers and public employees, who never received any of the benefits they are now being required to pay for.
In addition to forcing both groups to pay more, while getting less, the county also repeatedly cut the benefits offered to new hires to get its soaring retirement costs under control.
After reducing the retirement benefits offered to new hires in 2009 and again in 2013, the county earlier this year approved a plan to cut new employees’ benefits to the lowest level allowable under law, which are worth roughly half as much as those received by pre-2009 employees.
The current lawsuit that has delayed the implementation of this new, bare-bones retirement plan focuses only on how and when that plan will be implemented, not if.
This makes clear that all groups — including government employees — are harmed by the status quo.
Had the Board of Supervisors been informed of the true cost of the excessive and unnecessary 2002 benefit enhancement — and the degree of risk associated with relying on stock market returns to pay for it — this whole mess could have been avoided.
Requiring public pension funds like SDCERA to meaningfully account for risk will make it much harder for policymakers to force future generations to pay for their past funding failures.
And that’s good news for everyone concerned with the fiscal health of the county and the fair treatment of all its citizens — taxpayers and public employees alike.