This week, GASB approved new standards that would require state pensions that are less than 80 percent funded to base income projections on lower — more realistic, in fact — discount rates, down from around 8 percent to the 3 to 4 percent range. In a new report, the Pew Center for the States estimates U.S. state pension plans to be underfunded by a total of $757 billion (plus $627 billion for retiree health benefits).
However, that is likely too low, because Pew relies on self-reporting by the states, which are not eager to publicize large pension deficits. As Bob Williams, president of State Budget Solutions and a former auditor with the Government Accountability Office notes in the Washington Examiner today.
Pew acknowledges that its report uses states’ own actuarial assumptions about how much money they expect the pension fund to earn, on average, on investments now and in the future. The most dangerous deception in the Pew report is the failure to not recognize that public pension funds are putting more taxpayer and worker money into riskier investments at the very time they should be reducing risk as their employees age. That is just setting taxpayers up for a bigger catastrophe in the future.
Indeed, a recent study by researchers from Maastricht University and the University of Notre Dame shows that for underfunded pensions, overly risky investments make deficits worse. Pension smoothing does nothing to solve the problem; it only (partially) hides it, by enabling state pension fund managers to base future income projections on overly optimistic investment returns assumptions. Those overly optimistic return projections in turn lead to discount rates for pension fund contributions being set too high, allowing states to make lower contributions into their pension funds.
For more on public pensions, see here.