Hiding behind opaque numbers

Geoffrey Lawrence

Nothing pleases a politician more than the ability to promise lavish benefits to important constituencies without having to pay for them. Nevada lawmakers long ago found a vote-buying cash cow of this nature in the state's Public Employees' Retirement System (PERS).

PERS manages a defined-benefits pension system that operates much differently from the retirement funds owned by most private-sector workers. Participating employers in PERS — including the state and most local governments and school districts — commit taxpayers to annual up-front contributions on behalf of each government worker.

In some cases, the employee is responsible for matching taxpayers' contributions into his or her retirement fund. But, in many cases, collective-bargaining agreements at the local level stipulate that government workers will make no personal contribution toward their retirement benefits, leaving those benefits to be funded completely by taxpayers.

In total, these contributions must equal 23.75 percent of payroll for regular government employees and 39.75 percent for police and firefighters.

PERS administrators invest these initial contributions across a spectrum of stocks, bonds and private equities in the hopes of gaining a positive return. The supposition is that the return on these investments will suffice to deliver the retirement benefits that have been promised to government workers. Over the span of a career, 80 percent of a worker's retirement would, hypothetically, result from compound interest, while direct contributions would account for only 20 percent of the pension's value.

Here's where the math gets fuzzy, however.

To meet this goal without further exploiting taxpayers, PERS must earn an annual yield on investments of at least 8 percent. Should PERS falls below this target, the value of promised retirement benefits begins outweighing the value of assets that PERS actually has on hand — producing an "unfunded liability."

The unfunded liability is significant because, in practice, cities and counties across the nation have treated their retiree benefits as senior debt — continuing to make payments to retirees even when the municipalities have defaulted vis-à-vis bondholders. Claims to public-pension benefits are, hence, virtually "good as gold" — meaning taxpayers almost certainly will find themselves on the hook for any unfunded liability that results from PERS' annual yield falling below 8 percent annually. In effect, taxpayers are backstopping a guaranteed investment return for government workers, even as taxpayers themselves, in their own retirement portfolios, assume the markets' risks.

So, how realistic is it to assume an 8 percent rate of return year in, year out?

Seeking to provide a definitive answer to this question, the Nevada Policy Research Institute asked Andrew Biggs — a national public-pension expert and former principal deputy commissioner at the Social Security Administration — to examine PERS' finances and accounting assumptions. In a newly released NPRI report, "Reforming Nevada's Public Employees Pension Plan," Biggs concludes that, while an 8 percent rate of return might have been a plausible assumption in decades past, that assumption has lost its plausibility since the early 1990s.

The reason? If pension benefits are guaranteed, they should be backed up with risk-free assets or, at least, assets that have been price-adjusted to account for market risk. The quintessential risk-free financial asset is a U.S. Treasury bond and, although 30-year Treasury bond yields were in the 8-to-9 percent range in 1990, they have fallen steadily since and are near 3 percent today. Biggs concludes that it is unlikely Treasury bond yields will return to the 8 percent range in the foreseeable future and, consequently, that PERS must assume a high degree of risk in order to realize an average return of 8 percent.

Yet, PERS' actuarial assumptions do not account for the price of risk. Instead, PERS simply assumes that taxpayers will make up for the difference between its 8 percent assumption and its true yield — the unfunded liability — with higher contribution rates in the future.

Biggs shows that, when the price of risk is fully accounted for, Nevada's liability rises from the official number of $10 billion to $41 billion, and PERS' funding ratio falls from 70 percent to around 34 percent — meaning substantial future costs for taxpayers.

Nevada politicians have been happy to paper over this liability in the past, while promising ever greater benefits to government employee unions.

The day of reckoning, however, is coming.

Geoffrey Lawrence is deputy policy director at the Nevada Policy Research Institute. This article first appeared in Nevada Business. For more visit http://npri.org/.

Geoffrey Lawrence

Geoffrey Lawrence

Director of Research

Geoffrey Lawrence is director of research at Nevada Policy.

Lawrence has broad experience as a financial executive in the public and private sectors and as a think tank analyst. Lawrence has been Chief Financial Officer of several growth-stage and publicly traded manufacturing companies and managed all financial reporting, internal control, and external compliance efforts with regulatory agencies including the U.S. Securities and Exchange Commission.  Lawrence has also served as the senior appointee to the Nevada State Controller’s Office, where he oversaw the state’s external financial reporting, covering nearly $10 billion in annual transactions. During each year of Lawrence’s tenure, the state received the Certificate of Achievement for Excellence in Financial Reporting Award from the Government Finance Officers’ Association.

From 2008 to 2014, Lawrence was director of research and legislative affairs at Nevada Policy and helped the institute develop its platform of ideas to advance and defend a free society.  Lawrence has also written for the Cato Institute and the Heritage Foundation, with particular expertise in state budgets and labor economics.  He was delighted at the opportunity to return to Nevada Policy in 2022 while concurrently serving as research director at the Reason Foundation.

Lawrence holds an M.A. in international economics from American University in Washington, D.C., an M.S. and a B.S. in accounting from Western Governors University, and a B.A. in international relations from the University of North Carolina at Pembroke.  He lives in Las Vegas with his beautiful wife, Jenna, and their two kids, Carson Hayek and Sage Aynne.