Accounting Methods Often Mask Inconvenient Truth Of Pension Funds
Public pension funds across the country are playing a financial game of hide and seek, as retirement fund administrators use accounting gimmicks to give the appearance that all is right with their funds. In reality, the numbers game has created a massive sense of false security. Not only are countless pension funds drastically under-funded today, many have entered crisis territory.
In recent years, states and cities from California to Philadelphia have resorted to issuing pension bonds as a way to fill growing deficits in their retirement funds, while generating a higher return than what they paid in interest.
That was the plan anyway. As reported in a March 3 article by Bloomberg, back April 2007 the Chicago Transit Authority retirement fund opted for what it thought was a quick fix to raise money and boost its dwindling assets: issue $1.9 billion in pension obligation bonds.
As it turns out, the CTA retirement plan ultimately found itself paying out more to bondholders than what it took in from the new money, according to Bloomberg. Instead of reversing its funding gap, the CTA wound up digging itself into an even deeper financial hole by the end of the year.
According to the Center for Retirement Research at Boston College, public pensions in the United States showed total liabilities of $2.9 trillion as of Dec. 16, 2008. Their total assets are about 30% less than that, or $2 trillion.
Since then, stock market losses have wreaked further havoc on U.S. public pensions, causing them to be under-funded by more than $1 trillion. This lack of funds is one of the reasons that many U.S. retirement plans elected to issue some $50 billion in pension obligation bonds over the past 25 years, according to Bloomberg.
In the case of CTA, the retirement fund borrowed $1.9 billion by promising to pay bondholders a 6.8% return. The proceeds of the bond sale, held in a money market fund, earned 2%. That is 70% less than what the fund was paying for the loan.
Accounting gimmicks
Pension fund managers often use an array of slick accounting methods to play down or mask the severity of a pension fund’s true financial state. One of those accounting strategies is to report artificially higher expected rates of return.
Case in point: For the past eight years, the California Public Employees’ Retirement System has reported an expected rate of return of 7.75%. In actuality, its return has been 3.32%. In 2008, it lost 27%.
“It’s pitiful, isn’t it?” said Frederick “Shad” Rowe, chairman of the investment firm Greenbrier Partners, in the March 3 Bloomberg article. “My experience has been that pension funds misfire from every direction. They overstate expected returns and understate future costs. The combination is debilitating over time.”
Even before the nation’s credit crunch, many public pension funds were headed down a road of financial trouble. Now, with the stock market continuing to falter, those troubles are only multiplying. For many pension funds, the recourse is to issue pension bonds.
In 2008, the government of Puerto Rico borrowed $2.9 billion through pension bonds, betting that it could reap annual returns of 8.5% investing the money, while paying bondholders 6.5%.
So far the gamble hasn’t paid off. The 8.5% expected rate of return has become a loss of more than $200 million, according to Bloomberg.
Then there’s New Jersey. In 1997, then-Gov. Christine Todd Whitman sold $2.8 billion of bonds to help close a $4.2 billion deficit in the state’s pension fund. Later on, New Jersey increased benefits by 9% for some public employees after market gains closed the gap.
The strategy went by the wayside in 2001 as the economy slipped into a recession. According to a May 4, 2008, article in the Washington Post, pension fund returns fell below the interest rate on New Jersey’s bonds, and the state, faced with budget deficits, stopped making the annual contributions necessary to keep pace with rising costs.
In 2008, the Pew Center for the States, a not-for-profit public policy research group, reported that New Jersey’s seven retirement funds had a combined deficit of more than $28 billion, up 14% from 2007.
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