Aside from death and taxes, there are no sure things in life. Everything we do involves an element of risk.
The question then becomes: How much risk is reasonable, given the stakes?
In the private sector, most entrepreneurs have risked tens of thousands of dollars — or sometimes even tens of millions of dollars — pursuing opportunities to grow their businesses.
They did so because they believed the reward outweighed the risk. Some have succeeded and earned back many times their investment. Some have failed and lost everything.
Because business owners and investors risk their own money, they carefully analyze the risk and reward for each venture. Even then, investments in some businesses that were reasonable risks at the time nevertheless end up failing.
In the public sector, however, government officials don’t risk their own money. What they risk is the money of taxpayers. As a result, they’re often inattentive to the risks they’re running. After all, by the time reality comes calling, they may well be retired, in a new job or simply able to pass the buck.
That is what is happening with the Public Employees’ Retirement System of Nevada (PERS).
If PERS used the accounting methods required of private companies — say, Wynn Resorts or Southwest Airlines — everyone would acknowledge that it faces an unfunded liability of around $41 billion. That’s $41,550 per Nevada household — a funding ratio of just 34 percent.
But because PERS is a government-run and government-guaranteed plan, it is able to use laxer accounting standards. Even under these rules, PERS' unfunded liability is $12.9 billion, with a funding level under 70 percent.
Given that Nevada’s general-fund spending over two years comes in at around $6.6 billion, either amount signifies a crisis.
That’s why earlier this year, Gov. Brian Sandoval ordered a study on the financial health of PERS.
AonHewitt conducted the $50,000 report and released it last November. The report shows that Nevada's pension system will be fully funded in 2033 — if PERS averages investment returns of 8 percent a year for the next 20 years.
That may sound adequate, but as any entrepreneur knows, the devil — and the risk — is in the details.
So how much risk is there in PERS’ plan?
During the last five years, PERS’ actuarial value investment return, which is assumed to average 8 percent, failed to break the 8 percent mark even once. Using that as a benchmark, PERS’ plan has zero chance of success.
What if you go back nine years, to include the go-go years of 2005 to 2007?
PERS only broke the 8 percent mark once during that period. So, based on those last nine years, the odds of PERS achieving its investment returns in a given year are only 1 in 9, or about 11 percent.
What are the chances of PERS doing so each year for the next 20 years — as the report shows it doing? It calculates out to over 1 in 12 quintillion. That is: 1 in 12,000,000,000,000,000,000 — or one chance in 1 million times 1 million times 12 million.
That would be like starting with one blue coin, collecting 100 red coins a second for the next 3.8 billion years, jumbling them all together and picking the blue coin.
Now while past returns are no guarentee of future results and the investment environment may change profoundly in the next 20 years, these numbers show how risky PERS’ plan to get fully funded is.
So what happens when it doesn’t work?
We’re already seeing the first result: Taxpayers are already being increasingly squeezed, in the form of higher contribution rates for the pension system. As the AonHewitt report details, Nevada’s pension contribution rates are some of the highest in the country.
Increasing pension contribution rates, however, can’t go on forever, and rising pension contributions were a significant factor in the bankruptcy of cities like Stockton and Detroit.
The underlying legal question is: What happens to the benefits promised to government workers? Will they be reduced or eliminated or will future taxpayers have to foot the bill for past employees?
The risk to both groups is extremely high. Lawmakers should eliminate this risk for all involved by moving to a hybrid system that protects government employees and taxpayers.