The Washington Post

As you might expect, the subject of a recent American Academy of Actuaries forum was rather technical: the standards that state and local pension plans use to determine how much to invest to keep their retirement promises to government workers. While eye-glazing, this topic is critically important to state and local taxpayers because some of them may get stuck with an unexpected pension bill unless the actuaries, and the Governmental Accounting Standards Board (GASB), which will receive their recommendations, take a stand for accuracy and full disclosure.

As The Washington Post reported this month, state and local government pension plans, unlike many private-sector plans, are allowed to calculate the adequacy of their funding based on relatively rosy projections about their earnings. Instead of assuming a rate of return pegged to the lowest-risk investment, a 30-year Treasury bond (currently about 4 percent), they typically use a benchmark of 8 percent, which implies that they will do very well for very long periods in the riskier stock and bond markets. How likely is that? As Berkshire Hathaway Chairman Warren E. Buffett (a member of The Washington Post Co.'s board) noted in a recent letter to his shareholders, the Dow Jones industrial average, currently hovering around 11,000, would have to hit about 2,000,000 by the end of this century just to match the 5.3 percent annual rate of return stocks yielded in the last one.

Now, we have nothing against optimism, but in this case, it permits state and local officials to make sweet promises — high benefits, low retirement ages — to civil servants without having to raise the funds that might actually be necessary to keep them. This may not be good policy, but it's good politics since officials who make unrealistic commitments usually aren't around when they come due. To be sure, most pension funds are financially sound: 58 percent, according to a recent study by the Government Accountability Office. Even those that are underfunded are still meeting current obligations. Unlike private firms, governments probably should not accumulate surpluses in their pension funds because that creates political pressure to raid the excess for spending. And, unlike private firms, governments generally do not go bankrupt.

Still, it's not impossible. The city of Vallejo, Calif., declared bankruptcy in May, partly because it had granted police and firefighters six-figure pensions that kicked in at age 50. The U.S. population is aging, and long-term inflation is a fact of life. The actuaries and the GASB should urge state and local governments to play by more cautious — and more transparent — rules. For taxpayers trying to understand their governments' true pension liabilities, the best surprise is no surprise.

— The Washington Post