Smoke and mirrors: Part I
New PERS report is disingenuous
- Wednesday, December 29, 2010
Administrators at the Nevada Public Employees' Retirement System (PERS) have released a new study — one commissioned to provide political cover for the failing defined-benefits pension system that PERS operates.
The report uses a combination of spin and scare tactics in an effort to influence lawmakers not to tamper with the current defined-benefits system. Yet, the current system is constructed upon a pyramid of untenable accounting assumptions that have allowed taxpayers' unfunded liability toward retiring public employees to skyrocket over the past decade, moving from $2.3 billion in FY 2000 to more than $10 billion today.
The current defined-benefits system is financed through contributions from employees and taxpayers. To maintain solvency of the pension fund, the required contribution amounts vary from year to year depending upon actuarial assessments that reveal the valuation of PERS assets relative to promised retirement benefits. If PERS investments suffer large losses, then the gap between promised benefits and the valuation of the portfolio increases — necessitating larger contributions from employees and taxpayers in the next year.
The tricky part is that this calculation is not based upon the current valuation of PERS' assets — it is based on the expected valuation of those assets 30 years from now. It also assumes that, over the course of 30 years, PERS will average an 8 percent annual rate of return on a portfolio that bears zero risk.
For financial planners or economists, these assumptions immediately send up red flags. Typically, only purchases of federal Treasury bonds are considered to be zero-risk investments (and even that isn't true indefinitely). Yet, Treasury bonds only yield returns of 0 to 4.5 percent. The indefensible accounting assumptions used by PERS in this matter make it all but certain that the system's unfunded liability will continue to grow exponentially — requiring ever higher annual payments from employees and taxpayers.
There is a clear reason why PERS does not account for the pricing of risk in its portfolio. If PERS were to use more realistic assumptions, pitting the system's promised benefits against the expected valuation of its assets after 30 years while also accounting for risk in the portfolio, the unfunded liability would explode to more than $33.5 billion. In essence, PERS' fallacious accounting practices are used to paper over a cavernous hole of taxpayer liability.
PERS' latest report even admits to this fault. It says:
We have assumed the assets will earn 8% per annum on an actuarial basis even though there are large unrecognized losses that are expected to lower the actuarial return over the next few years as they are recognized unless these losses are offset by future asset gains.
Moreover, the report concedes that the defined-benefits system, as currently structured, routinely off-loads the unfunded liabilities owed to current employees onto future employees, in an inter-generational wealth transfer:
...this is the rate that will be sufficient to pay off the [unfunded liability] for current members over the next 30 years as long as all actuarial assumptions are met (including the payroll growth assumptions) in future years. If the [defined-benefits] plan were closed to new members, then the payroll for the [defined-benefits] plan would ultimately decline rather than grow during the 30-year period. As a result, the amortization component would increase significantly.
This looting of future generations to benefit current ones will likely continue into perpetuity without drastic changes to the system. There is almost no chance that "all actuarial assumptions" will be met "over the next 30 years" because the assumptions are so untenable to begin with.
This newest PERS report provides little more than propaganda for the status quo. The report's ostensible purpose is to compare the potential drawbacks and benefits of switching to a defined-contribution system. Yet, it fails to consider many of the most important benefits to retirees of a defined-contribution retirement plan.
The public should not be fooled.
Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute. For more visit http://npri.org/.