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States Play Fast and Loose With Employee Pension Funds « The Washington Independent

One of the reasons many people work for government even when there’s not a recession going on (despite the fact that government jobs often pay lower salaries than private sector ones) is the job security and generous benefits. Particularly for the younger generation of workers, there remain relatively few companies that offer traditional pension plans, but they still abound for workers in government jobs. But if Mary Williams Walsh’s story in The New York Times is any guide, those supposedly secure government pensions are growing less secure than the few private sector pensions left.

Willams Walsh reports that while private companies are shifting their pension investments into securities with lower rates of return and little risk, government pension funds are facing shortfalls and turning to risky stock market investments to make up for shorting contributions for years.

[Governments] use long-range estimates that presume high investment returns will cover most of the cost of the benefits they must pay. And that, they say, allows them to make smaller contributions along the way.Most have been assuming their investments will pay 8 percent a year on average, over the long term. This is based on an assumption that stocks will pay 9.5 percent on average, and bonds will pay about 5.75 percent, in roughly a 60-40 mix.

In other words, governments offered generous pensions to their employees, then paid less into their own pension system than the federal government allows corporations to do, while claiming that the stocks in which they invested would earn 10 percent each and every year, regardless of swings in the market.

That plan, says Williams Walsh, has worked out about as well as a regular investor might expect it would.

The problem now is that bond rates have been low for years, and stocks have been prone to such wild swings that a 60-40 mixture of stocks and bonds is not paying 8 percent. Many public pension funds have been averaging a little more than 3 percent a year for the last decade, so they have fallen behind where their planning models say they should be.

The pension fund contributions earned less than the rate of inflation in some years, meaning that they lost long-term value.

Now, if a regular person lost value in her 401k retirement fund, or saw that it wasn’t earning enough to fund her retirement, that person might put more into the retirement fund. But not a government pension plan!

“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, which oversees public plans in that state. “Double up to catch up.”Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now.

In order to earn the illusive rates of return that even marginally risky investments couldn’t provide, states are gambling their employees’ pensions on riskier investments — in part because they cannot afford to fund the plans adequately in the first place, let alone in the midst of yet another state budget crisis.

Of course, the elected officials in whose hands the decisions ultimately rest can’t cut benefits, admit that they underfunded their pension obligations or even cop to writing unrealistic rates of return into their pension plans to enable them to underfund their obligations. They’ve got every incentive to gamble that they can make up costs, especially given that they won’t be in office by the time the pension funds have real trouble meeting their obligations to employees.

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