Pittsburgh in Denial About Pension Assets

(August 27, 2012)–In yet another example of can kicking on a
critical public policy issue, the Pittsburgh pension board voted down
City Controller Lamb’s proposal to study whether Pittsburgh should
lower the current 8 percent rate of return on assets to 7.5 or 7
percent. The Mayor is quoted as saying that lowering the rate from
8.0 to 7.5 percent would require the City to increase payments to the
pension funds by an additional $9.3 million per year over and above
what it is currently contributing. Refusal to undertake a study seems
extraordinarily shortsighted. A lot could be learned about the
implications of the current level of unfunded liabilities and what
potentially lies ahead in terms of serious difficulties for the
pension plans under a scenario of continued very weak national
economic growth and slow tax revenue gains at the state and local
level.

As we noted in a recent Policy Brief (Vol. 12, No.40) state experts
on pension asset evaluation have called on the City to recognize that
its use of an 8 percent rate of return on assets and discounting
liabilities is too high in light of recent investment performance.
And even using the 8 percent rate of return/discount rate,
Pittsburgh’s funded ratio (assets to liabilities) is only 57 percent.
Obviously the City is not alone in having pension funding problems.
Note that Pennsylvania’s State Employee Retirement System (SERS),
which uses a 7.5 percent rate of return (and liability discount
rate), currently faces a $14.7 billion shortage in assets relative to
its liabilities and has a funding ratio of 65 percent. The ratio is
projected to fall to 55 percent by 2015 and will require substantial
increases in the Commonwealth’s contribution to the plan over the
next few years.

However, according to pension expert Andrew Biggs of the American
Enterprise Institute Pennsylvania’s problem is much worse than is
being portrayed. Mr. Biggs argues in testimony given to the state
legislature that if Pennsylvania were being held to the standards
imposed on private sector firms the state’s assets to liabilities
ratio would be only 40 percent and SERS would be facing a funding
shortfall of $42 billion.

Obviously, applying the private sector accounting standards to
Pittsburgh would dramatically increase its pension liabilities and
lower assets to produce a markedly lower funded ratio than the
current 57 percent while swelling the asset shortfall enormously.

As Mr. Biggs noted in his testimony, Moody’s has announced that it
will begin evaluating pensions by discounting liabilities by the same
rate of return being applied to assets, namely, the rate on high
quality corporate bonds. Such a change is estimated to triple
unfunded pension liabilities across the country.

This estimated tripling of unfunded liabilities provides some
perspective on the Pittsburgh situation. Little wonder the City
pension board just opted not to study lowering the 8 percent rate of
return/discount rate. The City claims it can simply not afford to
lower the rate at present because it would require diverting spending
from other City services. If lowering the rate of return to 7.5
percent–the rate currently used by the state–would cause the City’s
pension payments to rise by another $9.3 million and the state’s
adoption of private sector pension standards would nearly triple its
unfunded liabilities, it can be reasonably surmised that adopting
private standards by the City would massively increase its additional
annual pension payment while putting the plans on a much firmer
footing. Indeed, meeting private sector standards could easily double
the $9.3 million additional annual contribution requirement created
by lowering the rate to 7.5 percent.

The interesting thing to watch is how the state Legislature and
Governor address the gap between public pension accounting rules and
private accounting standards. To date, public standards have been
more lenient on the premise that if need be taxpayers can always be
taxed more to meet pension payment obligations. But as we are seeing
in California and other places, when tax burdens rise to unbearable
levels, raising tax rates is actually self-defeating as residents and
businesses leave. So it is understandable that Moody’s will be
adopting a stricter evaluation methodology for public pensions. The
fiction that taxpayers can be forever called upon to pony up more and
more to cover pensions while at the same time trying to maintain
adequate core government functions is now being revealed for what it
is–an illogical extrapolation based on never having encountered such
widespread overpromising by municipal governments.

If the national economy does not soon recover its footing and
accelerate to more traditional levels of growth experienced during an
economic recovery and then sustain more normal growth, public pension
plans all over the country are going to be in serious jeopardy of
being massively downgraded with the accompanying requirement to put
much more money into the plans. Will Pennsylvania’s lawmakers punt on
this or get ahead of the problem by lowering the rate of
return/discount rate to be used by the state, teachers and all
municipal pension plans? Or will they wait and hope for a national
economic miracle to bail them out?

Here’s the problem. Even if the economy strengthens and pension
performance improves somewhat, the lessons just learned cry out for
major reforms of pensions at both the state and local level. Defined
contribution plans must be adopted for all employees not currently
vested. Unions can be asked to renegotiate the generous terms of
pension plans for employees not yet retired. Years of service, final
income to be used as determining benefits and the percentage of
income per year of service should all be on the table. The
Commonwealth must also put stricter accounting standards on municipal
and teacher pensions as well.

Given the size of the current and pending funding shortfalls at the
state and local levels, there can be no excuse for not being better
prepared when the next major economic downturn happens.

Jake Haulk, Ph.D., President

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