Recently, the state of Minnesota joins a growing list of states with distressed pensions with its announcement that its pension liability is actually three times higher than originally thought. In a move that is reminiscent of a convoluted ponzi scheme, Minnesota made adjustments to its discount rate that balloon its pension liability from $16 billion to over $50 billion overnight. “It’s a crisis,” said Susan Lenczewski, executive director of the state’s Legislative Commission on Pensions and Retirement. Bloomberg reports:
The jump caused the finances of Minnesota’s pensions to erode more than any other state’s last year as accounting standards seek to prevent governments from using overly optimistic assumptions to minimize what they owe public employees decades from now. Because of changes in actuarial math, Minnesota in 2016 reported having just 53 percent of what it needed to cover promised benefits, down from 80 percent a year earlier, transforming it from one of the best funded state systems to the seventh worst, according to data compiled by Bloomberg.Li Lu And Greenwald On Competitive Advantages And Value Investing
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The change in liability is due to the concept known as a “discount rate”. The discount rate is the expected rate of return pension fund managers expect to receive- The higher the discount rate, the less the perceived pension liability. Many pensions use a discount rate of 7%-9% when realistic projections are more in line with 4%-5%. Applying this adjustment to the entire public pension system (changing the discount rate from 7.5% to 4%) increases its liability by 2.5 times. This is an increase from 2 trillion to 8.3 trillion. This is does not account for other risk factors like pensioners living longer or early retirement.
A Ponzi scheme is defined as a fraudulent investment vehicle that uses new investors to pay off older investors. Giving the current underfunded status of distressed pensions, it is clear that current pension contributors are paying for current pensioners or retirees. How are public pensions not a ponzi scheme?