If there is one thing that has always been certain, it’s the government employment safety net. Though the pay may not always compete with market rates – nor should it; it is public service after all – the lucrative post-employment benefits have always played a big role in luring people into public sector jobs.

Generous benefits, namely pensions, have led to the over $1 trillion in total government unfunded pension liability. That’s equals about a quarter of total outstanding municipal pension debt. Just in Texas, the state’s public employees have accumulated about $303 billion in pension benefits.

Growing unfunded liabilities can mean downgraded credit ratings, which lead to an increased cost for borrowing. They can also mean budget crunches, leading to reduced quality of services. While officials often incorrectly cite “low” tax revenue as the problem, growing unfunded liabilities are wholly a government-imposed problem.

As municipal budgets get tighter, local officials often battle between cutting services, debt service payments, pension payments, or the consortium of other things that come out of general fund budgets. Unfortunately for taxpayers, debt service and pension obligation payments are usually where the cuts come from, if at all.

Couple underfunding the pensions with lower-than-expected investment returns, contributions below the normal cost plus interest, poor actuarial projections, benefit changes, and changes to assumptions, and you have a recipe for ever-growing municipal and state pension debt.

Public pension funds have often erred on the side of riskier investments.

With riskier investments, the return can be higher, but in economic downturn the losses will be larger as well. As government costs have increased over the last few decades, contributions to pensions have been decreased to provide more budgetary flexibility for other expenses. It’s easier for politicians to cut future expenses than to face cutting direct spending or raising taxes. Decreases in funding meant increases in unfunded liabilities, so funds increasingly chose riskier investments in hopes of making up the difference. Despite the average investment return last year being around 5 percent, across the country assumptions in 2017 were as high as 8 percent. Three percentage points can equal millions of dollars.

Real returns are lower than expected returns, and serve as a main reason for increasing unfunded liabilities.

Another reason for the continuing growth in unfunded liabilities is the population covered by public pension plans is getting older, and active employees are increasingly becoming retirees and beneficiaries. A report on nationwide unfunded liabilities said, “the declining active to annuitant [retiree] ratio trend is a danger to the financial health of public pension funds …”

This is because contributions to pension funds go to cover current employee accruals as well as the gap in funding for retirees whose contributions weren’t made when they were active employees. To sum it up, this is a problem of a low active-to-retiree ratio.

Together, low investment returns and low contributions to the funds make up over 80 percent of the growing pension liabilities. While adjusting rates of return to more reasonable numbers would decrease outstanding unfunded liabilities, it would also engender more accurate reporting and allow more informed decision-making. At the same time, increasing contributions may put budgetary squeezes on other areas, but it would better position cities and municipalities for dealing with unfunded pension liabilities down the road.

 

Charles Blain

Charles Blain is the president of Urban Reform and Urban Reform Institute. A native of New Jersey, he is based in Houston and writes on municipal finance and other urban issues.

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