Pittsburgh in Denial about Pension Assets
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. The City is not alone in having pension funding problems. Note that Pennsylvania, 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 that is projected to fall to 55 percent by 2015.
But according to pension expert Andrew Biggs of the American Enterprise Institute Pennsylvania’s problem is much worse than it 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 would be facing an asset shortfall of $42 billion. Obviously, applying the private sector 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 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 voted to leave the rate of return/discount at 8 percent. The Mayor is quoted as saying that merely 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 putting in. Something the City claims it can ill-afford at present. Having to meet 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 rules and private accounting standards. To date, public standards have been more lenient on the grounds 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. 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 on to pony up more and more to cover pensions while at the same time trying to pay to maintain adequate core government functions is now being revealed for what it is.
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 attendant requirement to put much more money into their 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–a situation that could not be farther removed from the last three years’ experience.