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A Moody’s report last week warning that top US public pensions are underfunded by $2 trillion got wide coverage in the press.
“How bad is the public pension funding gap? This bad,” CNBC clickbaited.
“Largest Public Pensions Face $2 Trillion Hole, Moody’s Says,” reported Bloomberg.
“Some alarming numbers on the state of the nation`s public pension funds,” said PBS’s Nightly Business Report. “Pension Funding Gap is Now a $2 Trillion Chasm,” said NBC News.
Two trillion bucks is a big, scary number. But what does it mean, exactly, and how did Moody’s get there? We don’t get much of a clue from the press coverage.
Figuring out the relative well-funded-ness of a pension fund is a complex matter that’s as much art as science, as much opinion as fact. There is no final answer to the question. That’s largely because defined-benefit pensions, in order to account for their assets and liabilities, rely on investment gains and state contributions well into the future to gauge just how prepared they are to pay promised benefits in full.
Those investment returns are, of course, impossible to predict with any certainty, and they’re particularly subject to short-term distortions (the state contributions have a tendency to dry up too in hard times, which is a big problem). The stock market collapse in 2008 and 2009 hammered pensions. The raging bull market since has boosted them.
Last year, Moody’s–which, by the way, was a critical enabler of the financial crisis–rejiggered how it estimated future pension returns, dramatically lowering the return rate used to calculate them. In its story, Bloomberg reports that, “Moody’s announced it would take a more conservative approach to calculating liabilities than states and cities.” But that doesn’t really tell us just how conservative Moody’s is being, or what the implications of its very conservative methods are.
Moody’s is using a rate of return that’s far below normal levels. Where most public pensions assume average annual returns of 7.5 percent or 8 percent over the long term, Moody’s uses one that’s below 5 percent to get its results. That may seem like a small difference, but a couple or three percentage points makes a huge difference in longterm investment gains. While Moody’s estimates the top 25 pensions have $2 trillion in unfunded liabilities, the pensions themselves put the shortfall at $601 billion.
The economist Dean Baker, of the liberal Center for Economic and Policy Research, whose work has opened my eyes over the years to how the pensions issue is reported, wrote last year about the company’s new methods, “Moody’s change in accounting is not just bad politics, it is horrible policy.
If Moody’s methodology is accepted as the basis for accounting by state and local governments then they will suddenly need large amounts of revenue to make their pensions properly funded. This will directly pit public-sector workers, who are counting on the pensions they have earned, against school children, low-income families, and others who count on state supported services.
There’s no correct answer to what rate of return actuaries should use to gauge pension health, but it’s worth pointing out that pensions are better able to absorb short-to-medium-term setbacks than are individual investors. “State and local governments do not have retirement dates where they have to start drawing on stock holdings. They need only concern themselves with long period averages, without worrying about short-term fluctuations,” according to Baker. That justifies using higher return rates, he argues, as do the public pensions.
They’re hardly alone. In a November 2013 report, the big actuarial firm Milliman put the rate at 7.47 percent. It found that the top 100 public pensions (remember, Moody’s surveyed only the top 25) were underfunded by about $1 trillion, writing that, “most plans have set their interest rate assumptions and measured their pension liabilities in a realistic, actuarial manner that is consistent with long-term market return expectations.”
Neither Bloomberg nor Reuters reported that there were other, less alarming estimates on pension funding. Of course, all of this context on how pension funding is calculated is too much to squeeze into your typical 500-word news story. But particularly when there is no final answer on how well or poorly funded pensions are, it’s not ideal to report one estimate without noting how it differs from other estimates and why.
Another problem here is that Moody’s is using numbers that are nearly two years old numbers. That’s because that’s the latest data it had, but it was surely worth pointing out in news coverage that the stock market has jumped about 30 percent since those numbers were current. That will have had a significantly positive impact on pension funding levels.
Finally, there’s the issue of throwing out giant numbers like the $2 trillion in the headline without putting them in context, another issue that bugs Baker.
Over the next 30 years, total US economic activity will be more than $750 trillion, assuming 2.5 percent average annual growth in real GDP. Split it up over 30 years and the alleged shortfall comes to $67 billion a year or about 0.26 percent of GDP.
That’s a big number, all right, but it looks quite a bit more manageable than $2 trillion, particularly when you know that the shortfall is almost certainly not that much.
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