Setting aside money up front is the key to preventing pension disaster

San Jose Mercury News, 6/4/11.

By David Crane

Much has been written about the public pension problem, but not enough has been written about who is and is not responsible, and who are the victims.

Let’s agree that retirement security is a good thing and lacking for far too many Americans. In the public sector, that security is provided via defined benefit pension systems.

They can work perfectly well when enough money is set aside at the time the promises are made, so that, combined with investment earnings on those set-asides, enough money is in place when workers retire. The key is to set aside enough up front.

Establishing the level of those set-asides is similar to determining how much to save for your new baby’s college education. In that case you make a reasonable estimate of investment yields and then contribute enough money so that there will be enough when your child goes to college. If you’re conservative and assume a realistic rate of return, you will know with a high degree of certainty that the amount needed will be there. But if you assume an unrealistic investment return, you’ll set aside too little and risk your child not being able to attend college.

The same thing can happen in the pension situation. The difference is that pension payments are guaranteed and therefore must be paid by the government no matter the amount set aside. That means that if insufficient money is set aside when the promise is made, governments down the road will be forced to divert money from their programs to meet deficiencies. That’s what has been happening since early this century as public pension funds earned a fraction of what they expected.

Far too many commentators blame public employees and their unions for this problem, but that’s neither fair nor correct. Current and future public employees are actually victims. Moreover, in seeking pensions, public employees and their unions are no different from other stakeholders seeking government spending, including corporations. Most importantly, neither public employees nor their unions force legislators and governors to underfund pension promises. Legislators and governors can agree or not agree with one stakeholder or another.

Similarly, some commentators blame Wall Street, but that too is incorrect. Wall Street didn’t force pension fund officials to base their set asides on the assumption that 21st century investment returns would be 30 percent higher than 20th century returns. Other commentators blame the crash of 2008, but pension costs started rising well before then as a result of funds failing to meet assumed returns.

No, the parties responsible for under funding are the pension fund officials who don’t require sufficiently large set-asides when pension promises are made — and the politicians who make promises of the public purse without requiring adequate funding up front. The same is true of retiree health care promises, which currently receive small or no set-asides and as a result will impose growing burdens on future government budgets.

The victims are those who lose out when current budgets are invaded to make up for past failures to require sufficient set asides. That means public employees suffering layoffs, lower wage growth and reduced benefits; taxpayers paying more without getting more services in exchange; and college students, welfare recipients and others getting reduced services or paying more for services.

Solving the pension problem requires shared sacrifice, not invective and vitriol. No one is happy that our state now devotes more to retirement benefits than to UC and CSU. Addressing this will require tough choices. But going forward, retirement benefit promises must be adequately funded when the promises are made so that future generations won’t have to divert their funds to meet our promises.

DAVID CRANE was an adviser to Gov. Arnold Schwarzenegger and now lectures on public policy at Stanford University. He serves on the UC Board of Regents and the California High Speed Rail Authority. He wrote this for the Bay Area News Group.

Link to full article: http://www.mercurynews.com/ci_18203165?IADID=Search-www.mercurynews.com-www.mercurynews.com&nclick_check=1