Recently, the American Legislative Exchange Council (ALEC) has produced a report that is nothing short of alarming. The report suggests that the 7.5% discount rate utilized by many pension systems is nothing more than a flight into wishful thinking. When a realistic discount rate, such as the risk-free rate, is utilized the state’s pension system appears to be unconscionably unstable. The report entitled “unaccountable and unaffordable” exclaims, “Faulty accounting and reporting methods obscure the magnitude of unfunded liabilities.”
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The Governmental Accounting Standards Board (GASB) has heard these criticisms and have made two changes in 2012 to the methods used for measuring the supposed financial health of pension plans (Statement No. 67, Financial Reporting for Pension Plans and Statement No. 68, Accounting and Financial Reporting for Pensions). These changes were intended to increase transparency, provide consistency and comparability for the distribution of pension information. Nevertheless, the report by ALEC claims that “states have found ways to work around these requirements and paint an unrealistically rosy picture of their pension funding status.” The report goes on to say that when a risk-free rate of 2.142 percent (average of the 10 and 20-year U.S Treasury bond yields) is utilized the result is a pension system that is underfunded by an earth-shattering $6 trillion dollars. The state of California’s pension alone would be underfunded by $1 trillion using this same formula.
Some analysts are sounding alarmed for the potential fallout of these pension systems that will undoubtedly leave tax-payers on the hook. The personal share of the public’s per capita liability due to these funding shortfalls can reach as high as $67-500 - $115,650 per household. According to the report by ALEC, “Absent significant reforms, unfunded liabilities of state-administered pension plans will continue to grow and threaten the financial security of state retirees and taxpayers alike. The fiscal calamity could be far deeper and prolonged than the Great Recession. “
Of course, the financial media is focused on more important issues like the price of Bitcoin at this second so discussions on how to fix $6 trillion in pension funding will need to wait!