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August 22, 2014

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First step to fix pension woes: Proper accounting

Officials from Nevada’s Public Employees Retirement System recently announced that the system saw a 12.4 percent increase in value in the fiscal year that ended June 30, beating its 8 percent goal. There was no mention about the overall health of Nevada’s public pension fund. So does this mean Nevada is out of the woods as far as its unfunded pension liabilities? The simple answer is no.

Thirty-four states (including Nevada) fall below the “red flag” funding threshold of 80 percent for their public pensions. Nevada is at 71 percent. This means Nevada has 71 cents for every dollar in pensions it has promised. Despite some commentary, being at 80 percent funded does not mean the funding ratio is OK; it means that falling below this percentage indicates that the pension fund is in serious condition.

Both the Governmental Accounting Standards Board, which sets the accounting standards for the public sector, and Moody’s Investors Service, one of the nation’s major credit-rating agencies for state and local governments, recently enacted changes to the manner in which they calculate public pension liabilities. These changes were instituted because of the belief that state and local governments have underestimated the problem and severely distorted their pension numbers.

Analysts have suggested pension costs are significantly undervalued because states and local governments do not use their investment assumptions to project future growth and measure what they will owe retirees in the future in today’s dollars. These practices have been prohibited in the private sector since 1993. In addition, the typical public pension plan assumes its investments will earn average annual returns of 8 percent over the long term. However, actual experience has been much less, 5.7 percent over the past 10 years.

The standards board’s new rules, adopted in June 2012 and effective beginning in fiscal year 2015 for some portions and fiscal year 2016 for others, will likely show public pensions funds, including Nevada’s, are in a weaker financial position than previously thought. States and local governments will now have to uniformly calculate their net pension liability — the difference between the projected benefit payments and the assets set aside to cover those payments — up front on financial statements. Under the rules, pension funds that are considered adequate could continue to forecast investment returns with their historic averages. Funds lacking sufficient cash to cover benefits must lower their projections to about 3 to 4 percent.

While Moody’s does not have authority to make governments change their financial statements, they do control how they analyze and report government creditworthiness. Moody’s new numbers show that the 50 states have, in aggregate, just 48 cents for every dollar in pensions they have promised. This is much less than the 74 cents on the dollar (or funded ratio) that the states now report. Moody’s adjustment to the assumed discount rate for invested funds suggests that a rate of 5.67 percent is more appropriate. If the return rate is lower, the unfunded liability is higher and the funded ratio drops.

Despite needed pension reform, Nevada lawmakers chose to do nothing during the past legislative session. Instead, Nevada PERS commissioned a group to study the problem further. One area in need of immediate attention is the lack of public employee contribution into their retirement. Approximately 82 percent of public employees (mostly local government workers) contribute $0 from their actual paycheck. Nevada statutes require that these workers take “lower salaries” in lieu of paying into their retirement plans; however, in a collectively bargained environment, whether this actually occurs can be illusory. If this trade-off was actually happening, I don’t think we would consistently rank as having the highest local government salaries in the nation.

Increasingly, large portions of general fund budgets are being used to meet retirement promises to public employees, leaving less to spend on core governmental services. Such obligations hobble governments’ capacity to act and crowd out essential services and safety-net programs for citizens. The first step is for Nevada lawmakers, policymakers and public officials to ensure citizens are made aware of the scale of the problem by accounting for it properly rather than suggesting it will be magically fixed by the stock market.

Thom Reilly is a professor at San Diego State University and a former Clark County manager.

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