Last week I testified before the Pennsylvania General Assembly on their pension reform efforts. In my testimony I covered the valuation problem. While the state reports an unfunded liability of $39.5 billion. I calculate it is $116 billion. Like many other state and local pension systems, the mis-valuation problem caused Pennsylvania lawmakers to undertake a series of measures over the past several decades that further weakened the system. These include benefit enhancements when the market was booming and creating a “funding collar” which capped annual contributions to the pension plan effectively pushing that bill forward.
to the present
Pennsylvania has run out of time and costs are rising rapidly. In my testimony I cite the work of M. Barton Waring, whose book, Pension Finance, I highly recommend as an analysis of why economic valuation matters to the very existence of defined benefit plans. Without it, plans are subject to often questionable and arbitrary accounting choices. His analysis is well-grounded, consistent with theory and cogently explained.
He states his findings as a series of propositions that should guide how defined benefit plans are structured, valued and funded.
Proposition 1: Measures of the pension plan based on conventional accounting methods will always follow measures based on economic accounting sooner or later, even with a lag. The accounting will follow the economics sooner or later.
I think that proposition can been seen in the funding schedule for Pennsylvania’s two main pension plans: SERS and PSERS. As a result of artificially capping the state’s annual contribution to the plan, future contributions are slated to increase by 267 percent in the next five years. (And that is an underestimation since it is working off of the misvalued liability). Lawmakers know there is a serious hole ahead and as Waring’s book shows that is something that could have been avoided if plans had used economic valuation from the start.