December 1, 2008

Embrace Your Inner Underfunded Pension!

Carroll Andrew Morse

According to RI Future contributor Pat Crowley, if your pension plan is underfunded don't think of it as a bug, think of it as a feature…

An unfunded liability may in fact enhance the security of the plan because it requires more caution, therefore, more long term thinking.
I wonder if progressives will apply this line of reasoning to universal health care too -- sure there's no way we can pay for our proposals, but that's a good thing, because it means the government will plan them better! (The version of this kind of thinking often joked about amongst salespeople is "we lose a bit on every sale, but we make it up in volume.")

Anyway, back in the reality-based community, understanding why pension underfunding is a bad thing is straightforward. A pension plan is underfunded if, according to reasonable actuarial and design assumptions, it will run out of money before all obligations owed can be paid out. This situation should be avoided not only in pension plans but anywhere else in life. Claims from defined-benefit advocates that the current underfunding of Rhode Island's public pension system does not present a serious problem severely undercut the notion that defined benefit plans can be as cost-effective as defined contribution plans, if decades of total annual contributions equal to at least 25% of employee payroll are considered par-for-the-course for keeping a defined benefit system afloat.

In terms of present specifics, the underfunding of Rhode Island's state employee pension plan means that the state is required to contribute over 20% of employee payroll next year, to help get the pension plan to point where it will be self-sustaining by 2027, while still meeting all obligations until then. If the pension plan had been fully-funded (and never raided), the required state contribution would be much smaller, probably somewhere in the vicinity of 3% to 4% of total payroll per year. Given the current size of the state workforce, the difference between 4% and 20% of payroll is about $120 million, meaning that, if the state employee pension plan had been funded in accordance with its obligations assumed, $120 million more would be available to pay for existing programs or to reduce the deficit next year.

Finally, the pension study cited in Mr. Crowley's post takes a curious approach to the concept of "moral hazard". Here is the study's explanation of the concept…

If [pension plans’] investment decisions are being distorted by moral hazard, then we would expect to see less well-funded plans adopting more risky asset allocations.
But this formulation is incomplete. Moral hazard could also manifest itself in pension managers who don't believe they need to pursue a high-return (and associated high-risk) strategy because, hey, no matter how poor the investment returns are, as much money as is needed can be taken from future taxpayers – or should I say from current taxpayers, at a future time.

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1) I took a quick look over at the original post over at RI Future - someone in the comments was astute enough to have looked at the group cited by Mr. Crowley - and discovered that it is apparently an NEA front group. I'm shocked, SHOCKED!

2) The whole discussion is presumably intended to divert attention from the real issue - that public sector pensions in Rhode Island are GROSSLY "over-generous" and that all state and municipal employees should be immediately converted to a defined contribution plan. Don't let their red herrings about the "this won't solve the existing unfunded liability" fool you.

3) The probable inevitable end-game of FDR's New Deal - government at all levels has promised far more in "benefits" than the productive economy can ever hope to fulfill.

In 2006 the hardly alarmist / "vast right-wing conspiracy" Federal Reserve Bank of St. Louis published a piece stating that the U.S. is already insolvent because of pensions, Social Security, etc.:

Posted by: Tom W at December 1, 2008 12:07 PM

You can tell Crowley is a clueless union hack - never having to deal with the realities of life in his cushiony little cocoon.
What a dope you have to be to make this statement: "An unfunded liability may in fact enhance the security of the plan because it requires more caution, therefore, more long term thinking"
Actually, Crowley, the opposite is true. But then aagin, in your perverted little world up is down, and wrong is right. How about this idiot: it actually DECREASES the security of the plan, prompting bigger risks than otherwise might be prudent to try and make up the lost ground. That is the reality of an unfunded liability, amongst many other implications, NONE of them good. Get your head out of your stupid union butt!

Posted by: Mike Cappelli at December 1, 2008 8:08 PM

"An unfunded liability may in fact enhance the security of the plan because it requires more caution, therefore, more long term thinking"

By that reasoning, inasmuch as the state has had an unfunded pension liability for decades now, we ought to have the most secure pension plan on the planet.

Posted by: Monique at December 1, 2008 9:53 PM

Pat's idea seems to be to make the unfunded liability in the pension system so big, that it becomes "too big to fail."

Apparently, it's only bad when corporations which are "too big to fail" ask for public handouts, but it's okay for unions to do the same thing. No double standard there.

Must be one of those proletariat vs. bourgeoisie things.

Posted by: Will at December 2, 2008 12:51 AM

Union bigwigs are hardly part of any "proletariat".I don't think any of them live in third floor walkups with dicey space heaters and inadequate fire escapes.However,a lot of the workers who pay their salaries sure do.
As far as the teachers unions,there really are no "proletariat"people involved just based on salaries and benefits.

Posted by: joe bernstein at December 2, 2008 5:07 AM
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