The Foundation for Educational Choice has a new report today attempting to change the way we treat public pension plans. It essentially boils down to this: States themselves claim their pension funds covering teachers, principals, and other educators, are 78 percent funded, but the authors use different calculations based on what’s expected of private companies, derive another number and poof! the funding ratio drops to 60 percent. They then throw out the eye-boggling stat that states are actually $933 billion in the red due to unaccounted pension obligations.
Don’t believe it.
See, private pension funds are different than public ones, and they should be treated differently too. Private companies are required to contribute, on behalf of their defined benefit (DB) pension plans, to something called the Pension Benefit Guaranty Corporation (PBGC). The PBGC asks all employers with a DB plan to fully fund it so their future obligations are covered in case they ever go out of business or run out of money. When private employers fail to meet these obligations, they pay into the PBGC fund at higher levels. The PBGC can then compensate workers if their employer goes belly up. So when Enron, TransWorld Airlines (TWA), and Bethlehem Steel went bankrupt, their workers still earned some retirement benefits that had been promised them.
States, unlike private companies, do not fold under. Indiana, which according to the authors has a DB pension plan for teachers that is only 42% funded, is not likely to go out of business and take its workers down with it. The state of Indiana can assume a riskier investment return for its pension fund than an employer like those mentioned above or any other modern private firm (and, just for good measure, it’s worth pointing out that Indiana assumes only a 3 percent real rate of return).
All this is lost on the report’s authors, who would prefer states lower their assumptions on stock market returns from about 8 percent down to 6, the standard rate used by corporations in their calculations. This would mean telling a state like Pennsylvania, which has accumulated a 9.23 percent return in the stock market over the last 25 years (as of February 2010), that its 8 percent investment assumption is too high.
There are good reasons to consider changes in state pension plans, but this isn’t one of them. Expect more on this topic from Education Sector in the coming months.
Update: Stuart Buck, one of the co-authors of the study, responds here. Buck does two things wrong: One, he assumes that states are inherently bad actors willing to risk their pension money “gambling on a horse race.” That may be true in some cases, but the onus is on him to prove that all states are making such risky investment decisions, and thus need stricter rules on which they should be governed.
Two, he’s ignoring real world evidence. The document I link to above shows Pennsylvania has a 9.23 percent investment return over the last 25 years after one of the worst decades for investments on record. Buck can point to the fact that it’s down over the last five and a half years, but that’s clearly overshadowed by what’s happened in total. It seems reasonable to let a state assume what’s happened historically is likely to happen in the future. States and localities are afforded the long-term perspective, so they should be able to base their investment and interest assumptions on what’s happened over a very long horizon. The past doesn’t predict the future, but it shouldn’t be ignored either.