Nothing pleases a politician more than the ability to promise lavish benefits to important constituencies without having to pay for them. Nevada lawmakers long ago found a vote-buying cash cow of this nature in the state’s Public Employees’ Retirement System (PERS).
PERS manages a defined-benefits pension system that operates much differently from the retirement funds owned by most private-sector workers. Participating employers in PERS — including the state and most local governments and school districts — commit taxpayers to annual up-front contributions on behalf of each government worker.
In some cases, the employee is responsible for matching taxpayers’ contributions into his or her retirement fund. But, in many cases, collective-bargaining agreements at the local level stipulate that government workers will make no personal contribution toward their retirement benefits, leaving those benefits to be funded completely by taxpayers.
In total, these contributions must equal 23.75 percent of payroll for regular government employees and 39.75 percent for police and firefighters.
PERS administrators invest these initial contributions across a spectrum of stocks, bonds and private equities in the hopes of gaining a positive return. The supposition is that the return on these investments will suffice to deliver the retirement benefits that have been promised to government workers. Over the span of a career, 80 percent of a worker’s retirement would, hypothetically, result from compound interest, while direct contributions would account for only 20 percent of the pension’s value.
Here’s where the math gets fuzzy, however.
To meet this goal without further exploiting taxpayers, PERS must earn an annual yield on investments of at least 8 percent. Should PERS falls below this target, the value of promised retirement benefits begins outweighing the value of assets that PERS actually has on hand — producing an “unfunded liability.”
The unfunded liability is significant because, in practice, cities and counties across the nation have treated their retiree benefits as senior debt — continuing to make payments to retirees even when the municipalities have defaulted vis-à-vis bondholders. Claims to public-pension benefits are, hence, virtually “good as gold” — meaning taxpayers almost certainly will find themselves on the hook for any unfunded liability that results from PERS’ annual yield falling below 8 percent annually. In effect, taxpayers are backstopping a guaranteed investment return for government workers, even as taxpayers themselves, in their own retirement portfolios, assume the markets’ risks.
So, how realistic is it to assume an 8 percent rate of return year in, year out?
Seeking to provide a definitive answer to this question, the Nevada Policy Research Institute asked Andrew Biggs — a national public-pension expert and former principal deputy commissioner at the Social Security Administration — to examine PERS’ finances and accounting assumptions. In a newly released NPRI report, “Reforming Nevada’s Public Employees Pension Plan,” Biggs concludes that, while an 8 percent rate of return might have been a plausible assumption in decades past, that assumption has lost its plausibility since the early 1990s.
The reason? If pension benefits are guaranteed, they should be backed up with risk-free assets or, at least, assets that have been price-adjusted to account for market risk. The quintessential risk-free financial asset is a U.S. Treasury bond and, although 30-year Treasury bond yields were in the 8-to-9 percent range in 1990, they have fallen steadily since and are near 3 percent today. Biggs concludes that it is unlikely Treasury bond yields will return to the 8 percent range in the foreseeable future and, consequently, that PERS must assume a high degree of risk in order to realize an average return of 8 percent.
Yet, PERS’ actuarial assumptions do not account for the price of risk. Instead, PERS simply assumes that taxpayers will make up for the difference between its 8 percent assumption and its true yield — the unfunded liability — with higher contribution rates in the future.
Biggs shows that, when the price of risk is fully accounted for, Nevada’s liability rises from the official number of $10 billion to $41 billion, and PERS’ funding ratio falls from 70 percent to around 34 percent — meaning substantial future costs for taxpayers.
Nevada politicians have been happy to paper over this liability in the past, while promising ever greater benefits to government employee unions.
The day of reckoning, however, is coming.