The Wall Street Journal Andrew G. Biggs describes how the state of Montana is seeking to minimize the amount of its unfunded pension liability to be disclosed to the public ("Public Pensions Cook the Books," op-ed, July 6). He explains why state and local governments might wish to understate this figure, but says little as to why the various public employee unions -- ostensibly those which should be protecting the future pensions of their members -- aren't themselves insisting on a more honest and realistic calculation of this liability. I suggest there is a very practical reason for union acquiescence to an underestimation of the pension liabilities owed to their members: They have more to gain by maintaining the present system, as opposed to risking any changes to future benefits which might result from an honest accounting of the liabilities. Generous retirement benefits for teachers and other public sector employees, we are told, compensate them for the relatively lower wages they receive on the job. Long ago, this was likely the case. Yet over time, as teaching and other public sector jobs have increasingly become unionized, that wage gap (to the extent it still exists at all) has been reduced. But the generous benefit structure, from pensions to fully subsidized health care to vacation allowances, has been safeguarded by the unions and the administrators (many of whom are themselves union members). In other words, the pension and benefit systems are at the core of how teaching and other public employee unions maintain themselves. If the pension and benefit systems look more like the packages found in the private sector, it becomes harder to justify having a union. It seems that maintaining the system is the chief goal of public unions; paying for it is someone else's problem. W. R. Nelson Andrew Biggs's article reflects a misguided understanding of state and local pensions and government accounting, ignores salient facts and distorts key issues. He chastises government pensions for not using a corporate finance model that represents a settlement price, but fails to acknowledge that this is irrelevant to public pensions because they and their sponsoring entities are going concerns, not subject to takeover or going out of business. Rather than accuse the National Association of State Retirement Administrators of "taking the low road," had Mr. Biggs read our resolution on the subject, he would know our opposition to so-called market-based techniques is logical and fact-based. Further, the application of these techniques to corporations has been a leading cause of pension abandonment due to the extreme volatility they cause in funding levels and required costs. Mr. Biggs should also recognize that both actuarial and accounting standards support the use of the plan's long-term investment return assumption. This fact animated the state of Montana to insist on actuaries who would not espouse practices in conflict with the state's legal environment and actuarial and accounting standards. It is nonsensical to require state and local governments to calculate a settlement value for plans that are not going to terminate. The Governmental Accounting Standards Board considered and rejected so-called "market-based" techniques in 1994 when it established standards for calculating and reporting public pension liabilities. GASB instead found that trend-based actuarial measures, consistent with public plans' long-term nature, are a better gauge of a plan's financial condition than the single-point, market-based measures promoted by Mr. Biggs, a group of financial economists and those with a financial interest in the outcome of this debate. Terrance Slattery With regard to Mr. Slattery's letter, let me make this comparison to give a rough idea of what I'm talking about: Let's say that your pension plan owes $1,000,000 that it must pay 20 years from now. (This is a simplification of smaller cash payments over a longer period, but analytically that doesn't matter.) The question is, how much should you set aside today such that you can say you've "fully funded" that future obligation. Under the logic of state pensions, if you invest in stocks – with an average annual return of 10.7% per year – you only have to set aside $130,933. If that amount today earns 10.7% annually over the next 20 years, it will equal $1,000,000. 'Nuff said, right? Not really, since stocks are risky. The standard deviation of stocks has been around 18.5% per year. So, using a simple Monte Carlo simulation, I create 1,000 possible outcomes for that investment. Now, the average end balance is right around $1,000,000 – but that average can be very misleading. In fact, in almost two-thirds of cases, the initial $130,933 investment fails to equal $1,000,000 at the end of 20 years. This makes a travesty of the claim that the plan is fully funded. Now, if the plan were empowered to reduce benefits if investment returns were too low, then I could understand where they were coming from. But state pension benefits are generally guaranteed by law – the government can't get out of paying them short of default. If it's certain the benefits must be paid, then you want to discount your future benefit obligations at an interest rate that reflects that certainty. That will require you to set aside more money today, which the plans obviously aren't keen on doing, but clearly makes the plans more fully funded.
printed two letters in response to my article last week on accounting in state pension plans:
Glenview, Ill.
President
National Association of State Retirement Administrators
Santa Fe, N.M.
Friday, July 17, 2009
Responses to Wall Street Journal article on state pensions
Tuesday, July 14, 2009
I will now only post about pets…
I have a couple posts over at AEI's blog comparing cost growth in veterinary care – about the closest thing we have to a free market in health care – to health care for humans (see here and here). It's gotten good play, including at Greg Mankiw, Arnold Kling, Megan McArgle, Tyler Cowen, Bryan Caplan, Matt Yglesias and Brad DeLong. There's a little overinterpretation going on, which I should have hedged against with better warnings on data limitations – in particular, there's so little data on the size and composition of the pet population that working up a real "excess cost growth" number for Bowser & Co. is pretty tough. So all I've shown is dollar figures, which aren't optimal. The broader case, though, as the Consumer Reports quote illustrates, is that the same factors driving up health care for two-leggers – rising income and new technologies – are doing it for our furry friends as well. In any case, given the good coverage I will now only blog on pet-related issues.
Monday, July 13, 2009
Upcoming event: Australia and International Pension Reform: Lessons for the United States
On Thursday, July 16, 2009 at 10:00 a.m. the Retirement Security Project will host an event titled "Australia and International Pension Reform: Lessons for the United States" at the Brookings Institution, Saul/Zilkha Rooms, 1775 Massachusetts Ave, NW, Washington, DC. Some background: Achieving financial security in retirement is an increasing challenge as more responsibility is placed on individuals to put aside enough money during their working lives to last through their non-working years. Lessons from Australia's mandatory retirement savings system—the Superannuation Guarantee—continue to have a great deal of relevance to American policy-makers. On July 16, the Retirement Security Project and the Urban-Brookings Tax Policy Center will host Australian Assistant Treasurer Nick Sherry, an architect of the Superannuation Guarantee, who will discuss the system and recent changes to it. Following the assistant treasurer's address, a panel of international experts will discuss the relevance of the Australian system to several key proposals in the United States and other countries. After each presentation, speakers will take audience questions. Welcome William Gale Vice President and Director, Economic Studies The Brookings Institution Keynote Address The Honorable Nick Sherry Assistant Treasurer The Treasury, Australian Government Panel Discussion Moderator: David John Principal, The Retirement Security Project Senior Research Fellow, The Heritage Foundation David Harris Managing Director Tor Financial Dallas Salisbury President and CEO Employee Benefit Research Institute J. Mark Iwry (invited) Senior Adviser to the Secretary and Deputy Assistant Treasury Secretary for Retirement and Health Policy, United States Treasury Department Click here to register.
Friday, July 10, 2009
Cross posting from NASI blog
I left an extended comment to former SSA chief actuary Haeworth Robertson's post on the Social Security Trust Fund over at the National Academy of Social Insurance's blog.
Read more!
Thursday, July 9, 2009
Cross-country health care spending growth since 1990: how does the U.S. match up?
I have a new post at AEI's American blog today comparing health care cost increases in the U.S. to those in other countries since 1990. The conclusion: we're about average, and nations with more centralized health provision haven't been all that better at controlling costs over the last decade and a half than have we in the U.S. Here's the key chart: 
Sign up for NASI’s Social Security Academy
The National Academy of Social Insurance will be sponsoring a "Social Security Academy" for interns on Thursday, July 30, 2009 from 8:30am to 3:30pm. Among the topics are: Here's a link to sign up. I've spoken at the Social Security Academy in the past and thought it was a good event and well worth taking part in. Both the participants and the speakers are top notch.
Monday, July 6, 2009
New CBO numbers of aging versus health care cost growth
The CBO released new numbers dealing with the respective contributions to rising entitlement spending of population aging and rising per capita health care spending. As I noted previously, the analysis in CBO's new Long Term Budget Outlook support my previous arguments that over the next several decades, aging – not health care excess cost growth – will be the "real deficit threat." These new data break out aging and ECG-related costs in different ways. The key issues here is that the effects of aging and ECG are multiplicative, not additive. In English, this means that the total cost increase for entitlements will be larger when the two are put together than the sum of when either is viewed separately. The interactions between aging and ECG were a key issue in my original critique of CBO's November 2007 article, in which interactions were attributed entirely to ECG. I argued that the best way to present the interactions is to divide them proportionately between the two factors. This is the approach CBO took in their Long Term Budget Outlook. However, an equally valid approach is to two the interactions separately; that's what the new CBO numbers do. In either case, the conclusions are the same: according to CBO's projections, aging will be the largest driver of entitlement costs – and thus of overall budget deficits – until 2055. After that, excess health care cost growth will be the main entitlement cost driver. Given the time frame, and given that we'll be broke due to aging-related cost increases long before 2055, I think focusing exclusively on ECG in the near term doesn't make that much sense.
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