Public Pension Funding Liability 2x Higher Then Thought

This shouldn't come as a surprise to anyone. It's like ObamaCare - as time goes by, and after reading the fine print, we find that it will bankrupt the country. Much the same is happening with pension funds. After taking a closer look that just how states will pay the bill without raising taxes, politicians are finding they didn't read the fine print as well or they just ignored it like the rest of us do.

That is, ignoring the fine print for funding public pensions is like assembling something from the attacked print, when it doesn't seem to be going together like we thought it supposed to, we decide, when all else fails, it's a good idea to go back and actually read the directions.

States have learned their pension lessons now as tax payers strip away the red tape constructed by politicians over the years, forcing politicians to come out of the shadows, but is it too late to fix the problem as there aren't any direction to follow for such a mess.

The good news, nearly everyone now recognizes that we 'actually' have a problem.


Calculating the Market Price of Public Sector Pension Liabilities
Source: Andrew G. Biggs, "An Options Pricing Method for Calculating the Market Price of Public Sector Pension Liabilities," Public Budgeting & Finance Journal, Fall 2011.

State and local public sector employee pensions are widely known to be underfunded, but pension financial reports do not reveal the true extent of funding shortfalls. Pension accounting methods assume that plan investments can earn high returns without taking any account of the market risk involved. This gives a false sense of the financial strength of public sector pensions and understates risks to taxpayers.

Since accrued pension benefits are legally and constitutionally protected, any pension funding shortfalls must be met by taxpayers. This benefit guarantee amounts to an effective put option on plan investments, the cost of which is not disclosed under current actuarial accounting, says Andrew Biggs, a resident scholar at the American Enterprise Institute.

In a new paper, Biggs uses an options pricing method to calculate the market value of taxpayer guarantees underlying public sector pensions. The average funding ratio declines from 83 percent under actuarial accounting to 45 percent under this options pricing approach.

The typical state has unfunded public pension liabilities three times larger than its explicit government debt. Public pension shortfalls equal an average of 27 percent of state gross domestic product, posing a significant fiscal challenge in coming years.

Accurate measures of public pension liabilities are important for policymakers, taxpayers, investors considering the economic environment in which to start or locate a business, and bond purchasers considering the risk premia appropriate to municipal government bonds that are in practice subordinate to public pension liabilities, says Biggs.