Pension reform needed: Unfunded liability is a real problem
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I have it on good authority that “the private sector is doing fine.” But America’s public pension systems are struggling. The New Hampshire Retirement System recently downgraded the expected rate of return on its investments from 8.5 percent a year to 7.75 percent. Returns for Fiscal Year 2012 were just 0.7 percent.
New Hampshire’s pension plan isn’t yet the smoldering crater of California or Illinois, which means we still have to fix it. An off year for the stock market isn’t reason to panic. The expected rate of return is a long-term average, and last year saw spectacular returns of 23 percent. The New Hampshire Retirement System did a little better than the market last year and slightly worse this year, but basically we rode the same waves as other investors.
What’s most troubling is that even if we are able to average 7.75 percent, our liabilities are rising even faster.
Currently, the system has enough assets to make approximately 58 percent of its promised payments, a shortfall of $4.2 billion. That doesn’t include future funding of health care subsidies. Adding up all the unfunded promises of past Legislatures quickly adds up to a $5 billion problem that gets bigger every year.
It’s too early to calculate exactly how badly this year’s poor investment results will hurt the retirement system. Based on the historic annual increase in pension liabilities, my colleague Josh Elliott-Traficante estimates very broadly that the funding ratio could drop 3 to 5 percent. That means we’d have to come up with a way to pay for nearly half of the pension promises we’ve already made.
Ultimately, there are only four ways to pay for the unfunded liabilities in the New Hampshire Retirement System: cutting benefits, higher employee contributions, higher local and state taxes, or banking on rosy rates of return.
The unions representing state and local workers argue that lawmakers cannot alter the terms of their retirement benefits from the day an employee starts. They may prevail. If successful, the Legislature would be left with two just tools.
First, they could call on state and local governments to pay more for the retirement benefits of each current employee. Or they could put off those tax increases by pumping up the expected rate of return. If those returns didn’t materialize, future taxpayers would be solely on the hook for any shortfall.
It isn’t all that unreasonable to expect 7.75 percent from the stock market, but being overly optimistic, even a little, has a huge impact on the long-term viability of the system. The average annual return over the
past quarter century is around 9 percent, which we can certainly expect to reach in the next 25 years, assuming we get to invent the internet again. Historic returns for the last decade average 5.7 percent.
A new report from Andrew Biggs at State Budget Solutions argues states should be held to the same standard as private-sector pension plans and be forced to adopt a much more conservative rate of return. This would make the unfunded liability up to five times higher, and is why private firms stopped offering traditional pensions.
Asset growth is just one half of the vice squeezing the New Hampshire Retirement System. Liability growth is what’s really going to pinch taxpayers. Elliott-Traficante’s February report on the system found that even in good years, liabilities usually grow faster than assets.
The House is studying how to transition from the defined benefit pension plan which gave us a $5 billion headache to a defined contribution system, where public employees would receive a taxpayer match for their retirement.
Opponents argue that such a move would risk pension funds in the stock market. Well, we already do. This would shift that risk from taxpayers to employees. But it would also free public-sector workers from the whims of unions and politicians manipulating their pensions. And they would earn retirement benefits from Day One, rather than having to wait 10 years to vest in a pension.
Reforming the New Hampshire Retirement System for new employees won’t do anything to lower the system’s current unfunded liability, but it would stop us from adding to the problem every year. If you’re trying to fix a leaky pipe, the first thing you do is shut off the water.
Grant Bosse is lead investigator for the Josiah Bartlett Center for Public Policy, a free-market think tank based in Concord.
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Pension reform needed: Unfunded liability is a real problem « MNLABOR
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BOSSE: NH needs real pension reform, not just riding the wave « Watchdog News
[...] Read the complete commentary at New Hampshire Watchdog. [...]