State and local pension plans: risky business?

The Washington Post reports on Census data that shows state and local pension plans on the mend.

The improvement in many state and local pension plans are a result of better recent stock market performance and increased contributions by both employers and workers as a result of pension reforms that were passed in 2009.  Additionally, some of the improvement is also due to lower payouts to current pensioners as a result of reforms to rein-in high benefit costs. But a caution is in order. Plans are still valuing their liabilities using discount rates that underestimate the potential for continued volatility in the stock market, potentially over estimating future expected market returns.  Rather, state and local pension plans should be using a discount rate based on Treasury rates that reflect the guaranteed, risk-free nature of these pension promises. In other words, the current accounting understates pension liabilities.

One claim strikes me in particular. According to one union official, plans are now starting to recover from Wall Street’s risky behavior. How does this remark square with the explicit outcome of how pensions are currently valued – that is- the incentive to take on more portfolio risk in order to realize high expected returns?