By Iliya Atanasov and Charles Chieppo
Sunday, November 18, 2012
In the wake of the 2008 financial crisis and its impact on investment returns came the recent news that Massachusetts’ unfunded pension liability has grown to $24 billion. A closer look at the state fund and the commonwealth’s other 104 public pension funds reveals a troubling picture that will require far more than continuing to paper over our massive unfunded obligations with piecemeal reforms.
As the downturn showed, even minor fluctuations in investment returns have a huge impact on how much taxpayers ultimately pay for pensions. After a disastrous 2008 and 2009, the Legislature pushed out the deadline for retiring unfunded liabilities from 2025 to 2040.
State Treasurer Steve Grossman recently proposed reducing the state fund’s assumed annual rate of return from 8.25 percent to 8 percent. The Massachusetts Public Employee Retirement Administration Commission has suggested reducing the annual return assumptions for retirement boards across the state to between 7 percent and 7.75 percent.
These would be steps in the right direction, but they may still mask the real problem by being too optimistic. Private companies with traditional pension plans generally assume their pension funds will earn between 4.5 percent and 5 percent each year.
Current assumptions would see annual budgetary outlays by the state climb from just over $1 billion today to $3.2 billion by 2040. Those additional dollars have to come from somewhere, and they will translate into cuts in other services or new taxes.
A new Pioneer Institute study looks at three scenarios. The first is based on the still overly optimistic hope that we will see annual returns of 7.5 percent for the state’s pension fund investments. Under that scenario, state payments for unfunded liabilities alone would rise to $3.6 billion by 2040, about $400 million more than the current projected 2040 payment of around $3.2 billion.
Under a scenario with 5 percent annual returns, the 2040 payment would increase by more than $2 billion from $3.2 billion to about $5.25 billion. And a worst-case scenario, assuming annual returns of 2 percent (more or less the norm now), would see the 2040 payment by the state fund double to about $8 billion.
The largest portion of Massachusetts public pension fund investments is in U.S. stocks, which are likely to remain volatile for the time being. The second largest is in global stocks and emerging markets, which are even more volatile. Next are government bonds, which offer low yields and little upside.
Pushing back the date for retiring unfunded liabilities again certainly isn’t the answer. Payments increase each year — from just over $1 billion now to $3.2 billion by 2040 under the funds’ current assumptions. Extending the deadline means more years of $3 billion-plus payments, which would shortchange priorities like education, health care and infrastructure.
Public pension funds must adopt more realistic investment earnings assumptions. The additional money taxpayers will have to pony up over the next few years as a result is nothing compared to what it will cost if we continue to delay the day of reckoning. As chair of the state pension fund’s board, it is Grossman who must lead on this difficult issue.
Realistic investment assumptions and paying down unfunded liabilities more aggressively are just part of what will have to be much bolder pension reforms, like those recently enacted in Rhode Island. But they are indispensable if we are to achieve public pensions that are solvent, fair to employees and attract qualified and capable individuals to public service.
Iliya Atanasov and Charles Chieppo are senior fellows at the Pioneer Institute, a public policy think tank headquartered in Boston.