NPR reports that while many municipal and state governments’s pension systems are suffering from deep underfunding, there are some outliers. One such city is Milwaukee, Wisconsin. With a funding ratio of 90 percent, Milwaukee’s public employees’ plan would seem to have beaten the odds with a very simple (and laudable) strategy: fully fund the pension plan every year.
It is common sense. Make the full annual contribution and the plan can ensure that the benefits promised are available when retirement day arrives.
Except, thanks to government accounting guidance, it’s a little more complicated than that.
The problem is that the annual contribution the city is (prudently) making each year is calculated incorrectly. This flawed approach is why Detroit could claim a few short years ago that its plans were 100 percent funded. It is why New Jersey thought its plans were overfunded in the late 1990s.
Public plans calculate their liabilities – and thus the annual amount needed to contribute to the fund – based on how much they expect the assets to return. Milwaukee’s discount rate is 8.25%, recently lowered from 8.5%.
Unfortunately, if these liabilities are considered safe and guaranteed by the government, then they should valued as such. A better rate to use is the yield US Treasury bonds. In economist-speak: the value of liabilities and assets are independent. By way of analogy: Your monthly mortgage payment doesn’t change based on how much you think you may earn in your 401(K).
On a default-free, market valuation basis, Milwaukee’s pension plans is 40% funded and has a funding gap of $6.5 billion.
The good news – Milwaukee’s elected officials have funding discipline. They aren’t skipping, skimming, or torturing their contributions based on the desire to avoid paying their bills. And this can be said of many other cities and states. Funding a pension shouldn’t be magic or entail lots of uncertainty for the sponsor or employee.
But that leads to the bad news. Even when governments are responsible managers, they’re being sunk by bad accounting. Public sector accounting assumptions (GASB 25) lead governments to miscalculate the bill for public sector pension contributions. Even when governments pay 100 percent of the recommended amount – as it is presently calculated – this amount is too little to fully fund pension promises.
Last week I posted the Tax Foundation’s map of what pension funding levels look like under market valuation. Almost all state plans are under the 50 percent funded level. That is, they are in far worse funding shape than their current accounts recognize.
Until plans de-link the value of the liability from the expected performance of plan assets, even the best -managed plans are going to be in danger of not having put aside enough to pay these promises. Even the best intentions cannot undo the effects of bad accounting assumptions.