Another take on full funding of public pensions

23 May 2022

... From the taxpayers' perspective.

Should public retirement plans be fully funded?

Most state and local retirement plans strive for full funding, at least by actuarial standards. Funding measured at market values fluctuates and often falls short. In a model where most taxpayers hold debt and face intermediation costs, returns on pension assets are less than taxpayers’ costs of borrowing. Hence, zero pension funding is optimal. Also, unfunded pension promises are properly discounted at a rate strictly greater than the government's borrowing rate. Funding can still be in taxpayers’ interests if legal enforcement problems make unfunded pensions risky for employees, but except in special cases, the optimal funding ratio is less than 100%.

‘Neither a borrower nor a lender be’ (Shakespeare)

Pension "reform" and the governor's race

08 August 2018

[Remarks delivered at a Matt Brown for Governor event, August 6, 2018 -- We heard a bunch of stories from people who had relied on the state to uphold its promises to them, but who now find themselves stuck, rethinking career decisions made 30 years ago on the basis of trust in the government.]

The stories you're hearing hear are sad - and infuriating, but let's not leave things at that, and I want to tell you about the larger effects. And I'm not even talking about the story in this morning's New York Times about how bankruptcies among elderly Americans have tripled since 1991.

Since the 1980s, public pension funds across the country have amassed around $4~trillion in assets. The total GDP of the US is around $20~trillion. But it took 400 years of growth to get to $20~trillion, and less than one-tenth the time to get to more than one-fifth that amount in pension fund assets. This means that there have been years in my life when the bulk - if not all - the economic growth in the country was poured not into productive investments in our children, our roads, our citizens, but into sterile financial assets. This was great for stock market investors, but not so much for the rest of us.

If there were no other way to fund these benefits, one might say oh, our nation can't possibly afford these benefits, but there are other ways. We have chosen - our accountants have chosen - a very expensive way to pay for these benefits, and only a few politicians are bold enough to push back against the radical choices they have made for us.

I first wrote about pensions and the funding of pensions in 2005. When I was doing that, I kept reading things that didn't make a lot of sense to me. I wrote a little bit about how arbitrary the rules are way back then. How they seem to exaggerate the degree of crisis and how following the rules is more expensive than it needs to be just to pay benefits. And I heard a lot about it as a result.

Last year, the Haas Institute published a paper I wrote - a critique of the goal of fully funding a pension. I wrote that it's not necessary for a permanent enterprise like a government, that it's politically risky to be at 100% funding, that the urgency of the debt is exaggerated by the rules, that the size of these debts should be compared against the 50 years over which they're due, not the next year's budget. There were eight separate arguments, the legal, chronological, actuarial, mathematical, financial, economical, political, and philosophical.

And I heard a lot about that, too. John Arnold personally insulted me on Twitter, which was indeed an honor, though I don't think he actually read the paper. And right now I am working on a small research grant from the National Conference of Public Employee Retirement Systems to write a report about a broader critique of the accounting rules - full report is due in September, stay tuned. The research project included a substantial amount of solicited feedback from experts in the field, at workshop events in California, Illinois, and here. I had two actuaries come to one of the feedback events in California, just to tell me how wrong I am.

So I've heard a lot of response about my views on the accounting rules. But here's the funny thing, nobody refutes my points. Eight of them. I haven't seen one critic take on any of them with an actual argument - something that would say, here is what refutes that argument you're making. Not those actuaries, not the twitter critics, nobody. Instead they say, "Yes, but that's not the way we do it," or "Yes, but this makes the accounting work better," or "You're not an actuary." Or they say, "It's only fair to do it our way." Which is pretty funny to say to these teachers: that we're slashing their pension benefits in the name of fairness. But I kid you not, this is the quality of the responses that I've received.

And they say stuff like "You don't want us to end up like Detroit, do you?" Which is pretty funny, because pension debt didn't bankrupt Detroit, cuts in state aid did. Long-term debt might be worrisome, but it can't create a cash-flow problem, which is what actually sent Detroit into receivership. Besides, they can't even say who this debt is to. That is, unlike any other public debt you can name, nobody gets to book that pension debt as an asset.

Pretty strange, isn't it? Time is short, and last year's article is online. I'll just run through a few other weirdnesses, like being forced to put a number in the balance sheet whose potential error is larger than all the rest of the numbers in the same balance sheet. I'm a data guy -- you don't do that if you want good data. Or the way that you can pay off every dime of a debt and never be at full funding. These numbers just do not mean what they are widely supposed to mean.

So what do I want in a governor? I'll tell you what I don't want: just someone who is the best in the class at coloring between the lines. I want someone who questions why the lines are there and what they mean. If you're not doing that, you're not leading, you've just scrambled to the front of the pack. There is a difference.

What I want in a governor is someone who, when faced with a policy decision to make that could cause great pain to tens of thousands of citizens, will ask ALL the important questions. I want someone who will question the experts about their assumptions and make sure that there is no other way before inflicting that pain. We don't have that now, but we could. And that's why I'm happy to be helping Matt Brown today.

Someone agrees about pension funding

15 September 2017

From the San Diego Union-Tribune, an article about pension funding that cites my article:

If you’re a homeowner, you probably have a 30-year mortgage. Your mortgage allows you to own your home without fully funding the purchase. If, for example, you have a $300,000 home with a $150,000 mortgage, it might be said that your homeownership is at a 50 percent funded ratio. That’s not reckless; it’s prudent use of debt.


Some people speculate that future investment returns will be lower than past returns, requiring higher contributions from workers and taxpayers to sustain pension funds. In truth, no one knows.

The prudent course is to review returns each year and make gradual course corrections, as needed. That’s why independent auditors regularly evaluate and advise public pension funds on necessary course corrections.

So when you hear concerns about public pensions being underfunded, understand that ensuring 100 percent funding isn’t critical to the healthy functioning of a public pension system, and it can be very expensive.