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Moody’s $2 Trillion Public Pension Shortfall Estimate Highlights Need for Better Pension Accounting Practices

In a new report, Moody’s estimates the nation’s largest pension funds face a $2 trillion taken together. That’s a lot of money. But as significant as the size of the deficit is Moody’s criticism of how many pension funds have been managed, and pension fund’s reporting of their own liabilities. Bloomberg reports:

“Despite the robust investment returns since 2004, annual growth in unfunded pension liabilities has outstripped these returns,” Moody’s said. “This growth is due to inadequate pension contributions, stemming from a variety of actuarial and funding practices, as well as the sheer growth of pension liabilities as benefit accruals accelerate with the passage of time, salary increases and additional years of service.”

In other words, for years, many public pension plans have determined their contribution levels using discount rates based on overly optimistic projection on investment returns. That in turn, has led to pension plans using riskier investment strategies in search of higher yields—a strategy the California Public Employee Retirement System recently abandoned in the case of hedge funds.

Moody’s has also taken a critical approach toward many pension funds’ reporting of their own debts. As a result, it has opted to rely on its own estimates.

In April 2013, Moody’s announced it would take a more conservative approach to calculating liabilities than states and cities, such as by using market-based discount rates to “capture both the top-line liability growth and the material decline in interest rates.” Moody’s latest estimations of pension liabilities are higher in every case than those reported by the systems.

For states lawmakers, the discrepancy between the Moody’s shortfall estimates and the officially reported figures should prompt a thorough review of their state pension funds’ accounting practices. Arriving at a solution to the problem first requires a proper diagnosis.