As a former pension consultant-turned MIT Sloan professor, I get asked to speak at my fair share of pension conferences. I recently spoke at a symposium for trustees of Taft-Hartley funds, which are pension funds for unionized workers jointly trusteed by union representatives and management. After my talk, something unexpected happened: the audience gave me a hearty round of applause. This was unusual because often when I speak at these events, it seems people want to throw things at me.
Allow me to explain. I worked for over a decade in the pensions industry, and during that time and since, I’ve observed intense politicization around whether public (state and local) pension plans are adequately funded, and especially whether the actuarial rules for determining how much funding is necessary are up to the task. On one side are plan sponsors and actuaries who say that, based on traditional actuarial methods, the funds are in decent shape; and on the other side are economists (and a few actuaries) who contend that traditional actuarial methods understate and obfuscate the pension commitments state and local governments have made, and that the plans are in far worse shape than is generally acknowledged.
Whenever I try to discuss this with plan sponsors and others in the industry, I am typically given several (erroneous) reasons why financial economists are dead wrong on this issue.
Number one: The way in which economists value liabilities is short-term in nature. I often hear public plan sponsors and actuaries say something like: “Public pension funds are perpetual entities with a long-term perspective. The economics perspective, with its focus on the short-term, is not relevant for public funds.” This prompts economists to scratch their heads and wonder, “How did they ever get the idea our perspective is a short-term one?” Economists consider the entire life of a fund in their analyses, yet get painted as not understanding the long-term nature of public funds. The fact that this claim has no merit seems to have no bearing on the extent to which it is repeated as a defense of traditional actuarial methods.
Number two: Lowering the discount rate of the pension (i.e. calculating the value of the liabilities the way economists think it should be done) is not practical because the plan sponsor can’t afford the implied contributions to the fund. I was once at a conference where I raised the issue of how to choose an appropriate discount rate for public pension liabilities and whether presently used discount rates are too high. The head of a state pension fund said, “I would love to lower my discount rate, but the reality is that the state can’t afford the increase in contributions that would result.”
The fact is: there is a correct discount rate independent of whether the state can afford the contributions implied by the discount rate. Practical or political realities may “force” use of an inflated discount rate, but that doesn’t mean it isn’t inflated, and that certainly doesn’t mean that the resulting measure of the liabilities isn’t understated.
Number three: Economists have a political agenda to destroy defined benefit plans. It is hard to know if anyone really believes that financial economics is merely a weapon in a campaign to discredit public service and to disassemble our nation’s system of retirement security, but this argument has been made by defenders of the status quo, and once made it has been repeated as if it has credibility. As an observer who used to be in the thick of things, I feel frustrated. All this misinformation is somehow being propagated and it gives cover to plan sponsors and actuaries who wish to continue to make believe that public pension commitments are smaller than they are.
So, back to my moment in the spotlight at the conference for Taft-Hartley funds, which face the same issues as public funds. I asked the organizer and some attendees why they thought my talk was so warmly received, and they told me the answer was simple. “These are people who want to hear the truth, and they know you spoke the truth. They don’t want anything sugarcoated.” If only this attitude was more common among public funds, we might be able to begin to address the problem rather than arguing about it.