By Ryan Ekvall l Wisconsin Reporter
MADISON — It’s all over the news: Wisconsin’s public-employee pension system is the best in the nation.
The news telling the whole story.
A Pew Center on the States analysis of state pension funds rated Wisconsin Retirement System, or WRS, 100-percent fully funded, far better than states such as Connecticut, 53 percent, or Illinois, 45 percent.
The Badger State does indeed boast a healthy-looking plan, but its strength is based on sloppy accounting practices and borrowed money.
Economists say it’s a much better system than those that build their projections on expectations that fund investments will pay out like easy Vegas slots. But the state fund still assumes a 7.2 percent rate of return on its investments, known in the business as the discount rate.
If you think that’s reasonable investment planning, talk to one of Wall Street’s neighbors, New York City Mayor Michael Bloomberg.
“If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff,” Bloomberg recently told the New York Times, referring to convicted investment scammer Bernie Madoff.
The Pew study notes that it used Wisconsin’s own numbers to conclude the pension system is holding or will easily earn the $80.75 billion it needs to fund retiree pensions.
But use standard market valuations — change the expected rate of return from a sky-high 7.2 percent to a more conservative Treasury bill rate — and suddenly Wisconsin’s pension system is underfunded by $70 billion.
Using that assumption, the state pension plan is just 60 percent funded.
Andrew Biggs, economist at Washington, D.C.-based think tank American Enterprise Institute for Public Policy Research, or AEI, says that’s just one of the ways in which state pension actuaries could more accurately project future pension obligations.
“When you value a future liability — in this case, benefits that are guaranteed by law — the discount rate you apply to that liability must reflect the risk of the liability, not of the assets you set aside to fund the liability,” Biggs explained. “If WRS benefits are guaranteed, then you need to value them using an interest rate derived from investments that are also guaranteed.”
The adjusted rate would be closer to 3 percent — that of a long-term U.S. Treasury bond. Using a 3.6 percent rate, Biggs figures the state is underfunded by about 54 percent, or $62.6 billion.
Briggs isn’t a lone voice in the pension reform wilderness. The University of Chicago and Northwestern University in 2009 jointly called for governments to use Treasury bond yields, insisting assumptions at the time were loaded with risk. Northwestern used a 4 percent discount rate to conclude that Wisconsin’s fund is $56 billion in the red.
Actuaries at the Department of Employee Trust Funds, or ETF, value future liabilities based on, among other considerations, market outlook — their best predictions about how the market will perform. That allows for more generous forecasts.
ETF staffers argue that Biggs has the wrong idea, if only because using the market valuation rate “would increase the cost of the system significantly,” said Rob Marchant, deputy secretary at ETF. He says assuming lower rates of return would require taxpayers and workers to contribute more to fund maintenance.
Too bad, says Biggs. He points out that such political expedience ignores “taxpayers’ contingent liability to bail out pensions if they become underfunded.”
That is, if WRS fails to return 7.2 percent annually, at some point Wisconsin taxpayers will have to make up the difference.
Historically, the Wisconsin Retirement System has exceeded its projected rate of return. But the Great Recession did a lot of damage to old expectations. WRS returned 6.8 percent on its core fund during the past decade, and just 3.3 percent during the past five years — both of which are actuarial losses. The crash in 2008 wiped out $23.6 billion from WRS’ assets.
In this economic climate, 7.2 percent may be reaching.
Even discovering the state pension is only 60 percent funded doesn’t get at the truth. It turns out that nearly a million dollars in the fund was borrowed before the market crash.
In 2003, Wisconsin issued $950 million in auction-rate bonds to help shore up its pension plan. As CBS News reported in 2011, the bonds did well for a few years but got socked in 2007, when souring subprime loans started rippling into the auction-rate and other bond markets.
Counties and municipalities across the state also borrow to cover their share of the retirement system.
If it seems like Biggs and Marchant are talking past each other, it’s because they appear to be. Biggs, and others, argue the discount rate should reflect future liabilities. Marchant argues the discount rate should reflect how assets are expected to perform.
Expectation, again, has been tricky business, lately.
“That whole issue has been debated in our profession for quite some time and it’s still a matter of debate,” said Andy Peterson, a pension actuary at the Society of Actuaries. “It’s not that one’s right and one’s wrong. It’s the perspective.”
Unfunded pension liabilities estimated as much $4 trillion nationally offer their own perspective.
Biggs, like other free-market analysts, bemoans the scant political will to effectively address the question. There’s too much at stake, he said. Public employees and their unions resist changing a system from which they have benefited; politicians don’t care to show taxpayers the full bill — or, as in recent Wisconsin history, risk confronting the union leaders who occasionally fund their campaigns.
“If they did honest accounting, taxpayers would notice just how generous and how expensive these benefits are, and the public wouldn’t support it,” Biggs said.
“The future doesn’t like it,” he said, “but they can’t vote. Nobody who is a player in this wants to deal with it.”