“I’ll gladly pay you Tuesday for a hamburger today” was the trademark utterance of J. Wellington Wimpy, the mooching character from the old Popeye cartoons. These days, he might find work to pay for his burgers managing a public pension fund—while playing bingo after hours.
In recent years, state and local governments’ pension shortfalls have gained greater public attention, due in part to the 2008 financial crisis, which left many in even worse shape. But the financial crisis isn’t alone to blame.
For years, public pension managers have been contributing less than the actuarially recommended contribution, essentially eating the proverbial burger today while leaving a future patron to pay the bill. Then, as the burger bill grows larger and our friend Wimpy gets more worried about ever paying it back, he turns to playing bingo, making ever larger wagers in the hope of clawing his way out of the hole he’s dug for himself.
At that point, as the American Enterprise Institute’s Andrew Biggs explains in The Wall Street Journal:
[P]ublic-plan managers may see little option other than to double down on risk. In 2013 nearly half of state and local plan sponsors failed to make their full pension contribution. Moving from the 7.5% return currently assumed by Calpers [the California Public Employee Retirement System] to the roughly 5% yield on a 38%-62% stock-bond portfolio would increase annual contributions by around 50%—an additional $4 billion—making funding even more challenging.
But the fundamental misunderstanding afflicting practically the entire public-pension community is that taking more investment risk does not make a plan less expensive. It merely makes it less expensive today, by reducing contributions on the assumption that high investment returns will make up the difference. Risky investments shift the costs onto future generations who must make up for shortfalls if investments don’t pay off as assumed.
Shift pension obligations into the future long enough, and you’ll end up like New Jersey, whose dire pension situation was highlighted recently by my colleague Carrie Sheffield:
On pensions, New Jersey is a standout state, but in an unfavorable sense. States must pay into pension systems in specified levels (the jargon term is actuarially determined contribution (ADC)). During fiscal year 2013, 34 states contributed 90 percent of ADC or higher, while four states contributed less than 60 percent of ADC, with New Jersey the lowest at only 28 percent (second-lowest was Virginia, at 41 percent). On a Moody’s adjusted basis, New Jersey’s pension liability is $87.6 billion, or just over $9,800 per person, putting it at fifth place behind Alaska, Connecticut, Illinois and Massachusetts.
Clearly, some public pensions are managed better than others, but to put pensions on a long-term sustainable path, states and localities need to look for ways to move away from the defined benefit model, which promises a fixed payout amount and then manage the fund with the aim of earning enough to meet those obligations, and toward hybrid or, preferably, defined contribution model.
Until they do so, they’ll be gambling with the public finances and public employees’ retirement security.
For more on public pensions, see here.