AGA Today
Growing Deficits Threaten
Pensions
Accounting Tactics Conceal a Crisis For
Public Workers
By David Cho
Washington Post Staff Writer
Sunday, May 11, 2008; A01
The funds that
pay pension and health benefits to police officers, teachers and
millions of other public employees across the country are facing a
shortfall that could soon run into trillions of dollars.
But the
accounting techniques used by state and local governments to balance
their pension books disguise the extent of the crisis facing these
retirees and the taxpayers who may ultimately be called on to pay the
freight, according to a growing number of leading financial analysts.
State governments
alone have reported they are already confronting a deficit of at least
$750 billion to cover the cost of the retirement benefits they have
promised. But that figure likely underestimates the actual shortfall
because of the range of methods they use to make their calculations,
including practices that have been barred in the private sector for
decades.
Local governments
use these same techniques for their pension funds and face deficits that
further contribute to what some investors and analysts say may be
shaping up to be a massive breach of faith with a generation of public
employees.
This gap is
growing more yawning with the years. It has already presented taxpayers
with a whopping bill that is eating up a vast portion of government
budgets at the cost of other services. In
Montgomery
County,
for instance, pension and retiree health care costs are already higher
than the combined budgets for the departments of transportation and
health and human services. Eventually, officials responsible for the
funds will have to choose whether to continue paying out or renege on
benefits promised to retirees.
By their own
assessment, state and local governments acknowledge that their funds for
retiree benefits are increasingly falling behind, with the number that
are severely underfunded soaring to 40 percent in 2006, a five-fold
increase from 2000, according to the
U.S.
Government Accountability Office.
But even these
grim calculations are based on assumptions that some analysts consider
too aggressive, including projections about how the investments of
pension funds will fare and how long retirees will live.
"Very small
shifts in actuarial assumptions can generate huge changes over time,"
said Susan Urahn of the Pew Center on the States, which has studied the
issue. "It is not very transparent, and even where it is transparent not
many people understand it."
Pension funds
generate money from worker contributions, government payments and the
returns from investing that money. These funds pay an annual pension
salary and health benefits to retirees for as long as they live.
But with workers
retiring earlier and living longer, governments have been struggling to
keep up with the promises they made. Many are taking out loans to
restock their pension funds, which is akin to using a credit card to
cover monthly mortgage payments. Others are passing the bill to future
generations by using sunny projections of what their investments will
return, claiming they do not need to dedicate more money now to their
pensions.
Such "accounting
nonsense" has been "pushing the envelope -- or worse -- in its attempt
to report the highest number possible" for their investment returns,
wrote billionaire investor
Warren E.
Buffett
in a recent letter analyzing pensions for shareholders of his company.
Taxpayers ultimately will pay the price when these forecasts prove
wrong.
"Because the fuse
on this time bomb is long, politicians flinch from inflicting tax pain,
given that problems will only become apparent long after these officials
have departed," he wrote. "In a world where people are living longer and
inflation is certain, those promises will be anything but easy to keep."
Public pensions
have broad leeway in their accounting methods because, unlike their
counterparts in the private sector, they have no federal oversight.
Private pension funds were forced by regulators starting a generation
ago to use far more conservative forecasts in their pension calculations
and follow uniform guidelines set by the federal government. The move
toward stricter regulation provided a clearer picture of pension costs,
and many corporations are now switching their employees to 401(k)
retirement plans, which offer far less generous benefits.
For public
pension funds, a nonprofit body called the Governmental Accounting
Standards Board sets guidelines but has no power to enforce them and
little incentive to confront the states and localities that finance its
budget. So some states, pension analysts said, have adopted accounting
techniques motivated more by politics than prudent financial
considerations.
Virginia, for
instance, has been using an accounting method since 2005 that allowed
the state to contribute about $300 million less into its pension funds
each year than what its own pension board has recommended. Some pension
actuaries called this "highly unusual" and "troubling."
Maryland adopted
a funding formula in 2002 that prompted a sharp drop in pension funding
levels, ignoring repeated requests by the state's pension board to amend
this approach. In 2006, even as funding levels dropped, the state
significantly raised the retirement benefits promised to teachers and
other public employees.
The District's
pension funds are among the healthiest in the region, according to
figures provided by the governments. The District has determined that
its pension liability is $4 billion this year, which means the funds are
slightly overfunded. But if the District used more conservative methods
common in the private sector for projecting assets and costs, it could
instead face a shortfall of several billion dollars, analysts said.
In Montgomery
County, which has promised to pay $3 billion in health-care benefits to
retirees, government officials accepted the advice of consultants who
urged the county to nearly quadruple the amount it sets aside to cover
this commitment. But the county council voted to delay this full funding
for five years. Now the council, which claims wide legal latitude, is
considering whether to postpone it for another three years.
"The biggest
issue is the lack of standards in regards to government pensions," said
Timothy L. Firestine, Chief Administrative Officer in Montgomery County.
"You can make up your assumptions as you go."
Of all the
assumptions, among the most fateful is the figure chosen for how much
money the fund will make on its investments. The better these
investments fare, the more flush is the fund. And if a government
projects a high rate of return, there is less need to tap taxpayer money
to finance a shortfall.
Most public
pension funds limit their contributions by assuming their investments
will grow between 7.5 percent and 8.5 percent a year.
"While anything
is possible, does anyone really believe this is the most likely
outcome?" Buffett wrote in the most recent annual report his firm,
Berkshire
Hathaway.
Buffett is also a
Washington
Post Co.
director.
A growing number
of leading investors are warning that the return rates used by state and
local governments are unreasonably optimistic. Buffett, for one, has
pointed out that over the 20th century -- when the Dow Jones Industrial
Average soared from 60 points to 13,000 -- the stock market produced a
5.3 percent annual return for investors. Over the next century, the Dow
would have to explode to 2.4 million to produce a similar rate of
return.
Yet even that
would be less than the rate of return commonly projected by public
pension funds.
Many public
pension managers say their projections are based on past experience.
Moreover, they say they can take more risks than private companies
because there's no chance of going out of business.
"There's been a
government in our city since 1779," said
Mark Jinks,
chief financial officer for Alexandria. "You can't be sure that the
promises made to private sector employees will outlive their company."
Another concern
for public funds is demographic: We are living longer and more of us are
getting old. By 2015, life expectancy is expected to reach 79.2 in the
United States. By 2030, one out of five people will be over 65.
In addition,
retiree costs are soaring. A study by California predicted its retiree
health care costs would jump from $4 billion today to $27 billion by
2019.
Nor has the
crisis in the housing and debt markets helped matters. Investment
returns for most pension funds across the nation turned negative for the
first part of this year. State and local governments are also facing
budget deficits that are expected to top $30 billion next year,
according to Standard & Poor's, making it tough for officials to find
more funding for pensions.
Urahn, of the Pew
Center, called the current environment "a perfect storm" and expressed a
concern over whether governments may be tempted to cut their pension
contributions. Yet most are loath to revise the benefits employees have
traditionally been promised.
"The age of
retirement was set when people did not live that long. It's very hard to
change that now," she said. "People feel these pension obligations were
a promise. And changing them feels like you are breaking a contractual
promise, that you are changing the rules of the game. But the game has
changed."