New PERS report previews a slow-motion train wreck
Nevada taxpayers on the hook for unfunded liability of over $40 billion
- Wednesday, December 4, 2013
In the movie Dumb and Dumber, Jim Carrey's character, Lloyd, asks Mary Swanson, a woman he's interested in, “What are my chances?” She lets him know that his chances are “one out of a million.”
Carrey's character thinks about that for a moment and then excitedly exclaims, “So you're telling me there's a chance. Yeaaaaaaaah!”
The report found that Nevada's pension system will be fully funded in 2034 — if PERS averages investment returns of 8 percent a year for the next 20 years.
Currently, Nevada's pension system is grossly underfunded, which is the reason Gov. Brian Sandoval sought the study.
If PERS were a private-sector retirement plan, everyone would acknowledge that its unfunded liability would be around $41 billion, or $41,550 per Nevada household, with a funding ratio of just 34 percent.
But because PERS is a government-run plan, it is able to use different, and more lax, accounting standards. But even these relaxed standard shows that PERS' unfunded liability is $12.9 billion, which puts its funding level under 70 percent.
Since Nevada's biennial general-fund spending is around $6.6 billion, this unfunded liability represents a significant danger that should scare both government employees and Nevada citizens.
What happens when PERS doesn't have the money to pay promised benefits to retirees? Will a constitutional change or some kind of state bankruptcy allow Nevada to retroactively reduce payouts to retirees?
Or will Nevada taxpayers have to make significantly increased pension-contribution payments? This option would either crowd out other government services, such as education or roads, or it would mean a major tax increase, limiting private-sector growth and opportunity — or both.
The tricky part of identifying the depth of the problem is that, just like with your personal retirement account, assumptions make a dramatic difference.
Your retirement plan might be to spend $50 playing Wheel of Fortune slot machines, win $1 million and retire a millionaire.
Or your retirement plan could be saving $500 a month for 45 years at 5 percent interest and retiring with over $1 million in the bank.
Both are plans to become millionaires, but the second is dramatically more likely to succeed. Why? Because it uses realistic assumptions. Math tells you “there's a chance” your slot-playing plan will succeed, but it’s almost certain you'll wind up broke.
The same is true with Nevada PERS. The vast majority of the money PERS pays out in benefits will come from its investment earnings — which means that changing the assumed rate of return dramatically changes the results projected for 20 years from now.
The AonHewitt report shows how dramatically assumptions can change the unfunded liability. If PERS assumed a 10 percent rate in perpetuity, its unfunded liability would be just $2.1 billion and it would be 92 percent funded.
But if PERS’ actual rate of return is 5 percent, its unfunded liability is $35.8 billion, $36,281 per household, with just a 43.3 percent funding ratio.
That is the power of assumptions — and the danger to government workers and taxpayers. Assume the wrong thing now, and we’ll all pay a lot more later.
So what interest rate should PERS use to project future earnings and accurately reflect the size of its unfunded liabilities?
We could look at PERS’ actuarial value investment return, which is an average of its investment returns for the last five years. PERS uses this to “smooth” out investment returns, and it is this rate that is currently assumed to produce an 8 percent return.
The problem is that PERS' five-year average return is just 4.9 percent, and its nine-year average return is 5.8 percent. In eight of the last nine years, PERS has earned less than its needed 8 percent return. In 2009 and 2010, for instance, it earned returns of less than 3 percent.
The most accurate way to judge the size of the PERS liability, however, is to consider its liabilities at a guaranteed interest rate, which is currently around 4 percent. Making riskier investments can generate higher returns, but just like a private company, government should not be able to credit itself with those returns until they actually have been earned.
The needed solution? Shifting Nevada’s government employees to a hybrid plan that creates individual retirement accounts — which allows workers to have control over their own retirement and investment risk.
Union bosses, however, aren’t interested in giving up their gold-plated plans — which currently already allows over 1,000 retirees and beneficiaries to pocket $100,000-plus annually for the rest of their lives.
Instead, union officials and lobbyists will return to Carson City claiming the AonHewitt report shows “there’s a chance” the current system will work.
“There’s a chance” is a great motto for a Jim Carrey comedy, but a reckless philosophy for our state’s retirement system.
Victor Joecks is communications director at the Nevada Policy Research Institute. For more visit http://npri.org.