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: ‘Like telling a 30-year mortgage holder it’s all due at year’s end’ — Pressure on underfunded public pensions relies on flawed math

Just how healthy are U.S. public pensions?

While news media coverage — and critics — of public pensions often draw attention to large unfunded liabilities, a new study from a public-pension trade group offers a fresh way of viewing those liabilities — one they say is more relevant to how the economy and markets SPX, +0.31% work.

The group, the National Conference on Public Employee Retirement Systems (NCPERS), argues for a new approach to considering liabilities in the context of economic growth, known as “sustainability valuation.”

Critics of public pensions “compare 30-year pension liabilities, that is, liabilities that are amortized over 30 years, with one-year state and local revenues. They then argue that public pensions are unsustainable,” writes the author of the NCPERS report, Michael Kahn.

“Comparing 30-year pension liabilities to one-year state and local revenues is like a bank telling the borrower his or her 30-year mortgage is due at the end of this year,” he said.

NCPERS argues traditional methods of presenting pension liabilities are often misleading. Source: NCPERS

Instead, Kahn writes, outstanding public pension liabilities should be placed in the context of the 30-year period in which they are amortized, rather than being considered as something that must be paid down immediately.

NCPERS argues its approach to analyzing revenues and liabilities is more accurate. Source: NCPERS

Kahn argues that such an approach should be an additional tool for monitoring how well-funded and sustainable a pension plan is, in addition to existing, familiar approaches like actuarial analyses and stress tests.

He urges “monitoring sustainability on an ongoing basis and making fiscal adjustments to keep the ratio between unfunded liabilities and economic capacity stable at, say, the average of the past two decades.”

As an example, he points to a 2020 opinion piece from the Chicago Tribune, which claims that pension liabilities in Illinois total 10 times state and local revenues. “That certainly looks terrifying,” Kahn writes, “but it is the wrong comparison. When we compare pension liabilities that are amortized over 30 years with 30-year revenues (an apple-to-apple comparison), they are only about 8% of revenues.”

While finding a new and more attractive way to frame liabilities can be appealing, the NCPERS report adds to a recent wave of public-pension research that argues that there are good reasons to bring broader context to the issue of pension funding.

A 2021 working paper from the Brookings Institution challenged the idea that state and local governments must fund pensions in full — that is, for the entire 30-year period Kahn references above.

Governments “don’t have to pay off their debt like a household does,” said Louise Sheiner, one of the co-authors of the Brookings paper, in an interview with MarketWatch. “They can just keep rolling it over. They’re never going to go out of business and have to pay all at once.”

See: Public pensions don’t have to be fully funded to be sustainable, paper finds

To be sure, there are some public-pension plans whose funding levels are not sustainable, and which should be urgently addressed. The Kentucky Employees Retirement System, one of the most under-funded systems in the country according to data from the Center on Retirement Research at Boston College, was only 16.5% funded as of 2019.

See: He runs the worst-funded public pension in the country. Here’s his ‘good news’ story

What’s more, any analysis of sustainability relies on governments making the contributions required of them in both good times and bad, something that hasn’t always happened.

But there are also sound reasons to be critical of descriptions that frame pension situations as dire amid a push to fully fund. Among them: devoting an outsize portion of an operating budget to future expenses can crowd out real current needs, such as schools or capital projects.

Also, the perceived need to fully fund 30 years’ worth of liabilities may cause municipalities to engage in financial practices that are arguably more risky or harmful, such as taking out debt to plug the pension gaps.

Read next: State and local governments have issued more pension bonds this year than ever before

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