State Retirement Funds Play Tricks on Retirees, Taxpayers

by Dannie Mahoney, Heartland.org, November 14, 2014

Awareness of the problem of underfunded public pensions is increasing among the public, as states seek to balance their budgets without reneging on prior agreements with workers, but a less publicized liability problem is also becoming an issue. All too often, states’ retirement health benefits programs are over-promising and under-funded.

State governments, in the aggregate, have set aside four cents for each dollar of promised health care benefits. In addition to this concerning trend, some states have started using an accounting trick to hide this debt from the balance sheets—effectively sweeping the debt “under the rug” and out of sight.

Historically speaking, public retirement health care programs have incurred more debt than public pension programs’ debt—a trend which has reversed in recent years.

Papering over the Problem

Unfortunately, some of the improvements in healthcare programs’ finances are false. For example, Alaska, Hawaii, and Michigan have employed gimmicks to give the appearance of fiscal improvements in their entitlement programs.

Most states maintain a zero balance in their retirement health fund to cover expenses. As there is no money in the fund, the state can “low-ball” its rate of return on debt owed, assuming a pessimistic 4 percent rate of investment return.

When money is eventually placed into the health fund, this trick allows state governments to claim that the fund has been “pre-funded”—making the fund appear much healthier than it may be in reality, as a second, more optimistic rate of return is assumed.

By triggering overly optimistic funding scenarios through the manipulation of fund balances, states engineer perceptions that their retirement healthcare fund reserves are filling up faster than they are in reality.

Generally speaking, state pension funds assume 8 percent returns on pension investments—a wild over-assumption. Studies by the Pew Charitable Trusts found state entitlement funds’ investments had seen a 3.9 percent average return over the past decade.

The average state has a total pension and retirement health care debt of over 22 billion dollars, but over 80 percent of that debt—almost 19 billion dollars—is hidden from citizens and state legislators, in due to accounting gimmicks.

Fixing the Structure

Using these accounting “tricks” understates governments’ unfunded liabilities by billions of dollars.  However, not all states are playing tricks on their taxpayers.

In Kentucky, the actual value of healthcare and pension claims was significantly lower than expected, allowing the state to revise its expectations and lower its debt load.

Other states have enacted structural reforms to their systems, which improved their fiscal outlooks. In Ohio, increasing the age of retirement for employees has served to decrease the estimated amount of money required to fund retirees’ retirement healthcare.

Citizens will ultimately be responsible for the real value of the debt, no matter what the estimated rate of return. Unless other states follow the lead of Kentucky or Ohio by making real reforms to pension structures, future taxpayers will be forced to make up the difference if the fund does not have enough money to pay benefits owed to retirees.

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Dannie Mahoney (dmahoney@truthinaccounting.org ) is Media Relations Manager for Truth in Accounting.