When the Pew Center on the States recently described the Wisconsin Retirement System (WRS) as a "solid performer," public-sector advocates interpreted this as a repudiation of Gov. Scott Walker and his attempts to rein in public employee pensions.
But Pew did not independently audit the WRS or any other pension plan it reported on. To survey the health of state pension plans, Pew simply used the data and assumptions published by each pension system. In other words, since the WRS assumes it will earn 7.2 percent on its investment returns going forward, Pew assumed that, too. And since that assumption allows WRS to say it's in great shape, Pew drew that conclusion, too.
Now a recent study by the actuarial firm Milliman is also being cast as proof that things aren't really so bad with public pensions.
But Pew did not independently audit the WRS or any other pension plan it reported on. To survey the health of state pension plans, Pew simply used the data and assumptions published by each pension system. In other words, since the WRS assumes it will earn 7.2 percent on its investment returns going forward, Pew assumed that, too. And since that assumption allows WRS to say it's in great shape, Pew drew that conclusion, too.
Now a recent study by the actuarial firm Milliman is also being cast as proof that things aren't really so bad with public pensions.
Unlike Pew, the Milliman study does question each pension plan's assumptions but, like Pew, Milliman does not address the key underlying issue.
Public pensions typically discount their future obligations using the expected rate of return on their investments. Milliman's contribution was to look at the actual investments held by each plan and decide for itself whether each plan is calculating the expected rate of return accurately. In other words, maybe the expected return on a given plan's investments should be 7.75 percent or 8.25 percent rather than 8 percent.
This is somewhat interesting, but it does not tackle the crucial problem with public pension accounting: The expected rate of return, whatever its precise level, is conceptually not the correct discount rate to use in the first place. A much lower discount rate--something close to the risk-free rate--is the approprate rate to apply to a liability that is virtually guaranteed to be paid.
Until public pension plans are required to use risk-free discounting, the real cost of their obligations will remain obscured from public view.
Public pensions typically discount their future obligations using the expected rate of return on their investments. Milliman's contribution was to look at the actual investments held by each plan and decide for itself whether each plan is calculating the expected rate of return accurately. In other words, maybe the expected return on a given plan's investments should be 7.75 percent or 8.25 percent rather than 8 percent.
This is somewhat interesting, but it does not tackle the crucial problem with public pension accounting: The expected rate of return, whatever its precise level, is conceptually not the correct discount rate to use in the first place. A much lower discount rate--something close to the risk-free rate--is the approprate rate to apply to a liability that is virtually guaranteed to be paid.
Until public pension plans are required to use risk-free discounting, the real cost of their obligations will remain obscured from public view.
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