States Seeking to Reduce Pension Liabilities

At a time when states are facing large budget shortfalls, many are looking for ways to cut pension costs and use this savings to balance the state budget.  To achieve savings, benefits of employees not yet hired are being reduced, which allows a state to factor in the savings in the current term because it reduces the unfunded liability of the system in the future.  According to the New York Times, this practice has been raising flags in a number of states, including Illinois, Rhode Island, Texas, Ohio, and Arkansas.

Actuaries have been using the method for years, it turns out, but nobody noticed, in part because official documents usually describe it in language few can understand.

The technique is fairly innocuous in normal times, allowing governments to smooth out their labor costs over many years. But it becomes much riskier when pension funds have big shortfalls, when they need several decades to pay down their losses and when they are cutting benefits for future workers — precisely the conditions that exist today.

Cuts for workers not yet hired do not save much money in the present — but that’s where actuaries can work their magic. They capture the future savings for use today by assuming, in essence, that 100 percent of today’s work force is already earning tomorrow’s skimpier benefits. When used in actuarial calculations, that assumption has a powerful effect. It reduces the amount a government must put into its workers’ pension fund every year.

That saves the government money. But it undermines the pension fund, which must still pay the richer benefits of today’s retirees. And because the calculations are esoteric, it is hard for anyone except a seasoned actuary to see what is going on.

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