Andrew G. Biggs

The Show-Me Institute recently released a study that I authored about Missouri public employee pensions. The study argued that pensions should value their future benefit liabilities using a low “discount rate” to account for the fact that retirees’ benefits are legally guaranteed, regardless of how the plans' investments turn out. The study cites numerous sources, such as the Federal Reserve, the Congressional Budget Office, and others arguing for so-called “fair market valuation.” If you value guaranteed public pension liabilities using a safe 4 percent interest rate, rather than the 8 percent rate that is common for public plans, Missouri’s unfunded pension liabilities rise from about $11 billion to $54 billion.

The St. Louis Post-Dispatch’s David Nicklaus brought these results to Gary Findlay, executive director of the Missouri State Employees Retirement System (MOSERS) and an outspoken opponent of fair market valuation. “Using a risk-free discount rate, Findlay says, is about as sensible as arguing that the state should take a zero-risk approach to traffic accidents — by banning cars.”

In fact, fair market valuation does not say that pensions cannot take investment risk. Nor does it argue that investment risk cannot pay off. Rather, it merely says that we cannot assume that investments always pay off and ignore the risks those investments pose to the budget and the taxpayer. Under current pension accounting rules, a plan that takes more investment risk — say, by shifting into stocks, private equity, or hedge funds — automatically becomes “better funded” because the plan then assumes a higher investment return. But high-risk investments do not make pensions better funded. Yes, they reduce contributions for current taxpayers — but shift an equal and opposite contingent liability onto future generations to pay full benefits should the assumed rates of return fail to materialize.

And, as recent experience has shown, riskier investments do not always pay off, even over the long run. In fact, MOSERS’s own investment consultants told them that the plan has a less than 50 percent chance of achieving its stated returns. But full benefits must be paid 100 percent of the time. Fair market valuation catches the cost of guaranteeing full benefits. Current accounting standards ignore it.

Findlay’s traffic accident analogy is not the most apt, but think about it this way: Automobiles come with obvious benefits but also costs, including the risk of traffic accidents. But we cannot weigh the costs and benefits if we refuse to count the number of accidents each year. Similarly, we cannot refuse to consider the possibility that our bets on high-risk pension investments will not pay off, particularly when billions of taxpayer dollars are on the line.

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Andrew Biggs