Embrace Your Inner Underfunded Pension!
An unfunded liability may in fact enhance the security of the plan because it requires more caution, therefore, more long term thinking.I wonder if progressives will apply this line of reasoning to universal health care too — sure there’s no way we can pay for our proposals, but that’s a good thing, because it means the government will plan them better! (The version of this kind of thinking often joked about amongst salespeople is “we lose a bit on every sale, but we make it up in volume.”)
Anyway, back in the reality-based community, understanding why pension underfunding is a bad thing is straightforward. A pension plan is underfunded if, according to reasonable actuarial and design assumptions, it will run out of money before all obligations owed can be paid out. This situation should be avoided not only in pension plans but anywhere else in life. Claims from defined-benefit advocates that the current underfunding of Rhode Island’s public pension system does not present a serious problem severely undercut the notion that defined benefit plans can be as cost-effective as defined contribution plans, if decades of total annual contributions equal to at least 25% of employee payroll are considered par-for-the-course for keeping a defined benefit system afloat.
In terms of present specifics, the underfunding of Rhode Island’s state employee pension plan means that the state is required to contribute over 20% of employee payroll next year, to help get the pension plan to point where it will be self-sustaining by 2027, while still meeting all obligations until then. If the pension plan had been fully-funded (and never raided), the required state contribution would be much smaller, probably somewhere in the vicinity of 3% to 4% of total payroll per year. Given the current size of the state workforce, the difference between 4% and 20% of payroll is about $120 million, meaning that, if the state employee pension plan had been funded in accordance with its obligations assumed, $120 million more would be available to pay for existing programs or to reduce the deficit next year.
Finally, the pension study cited in Mr. Crowley’s post takes a curious approach to the concept of “moral hazard”. Here is the study’s explanation of the concept…
If [pension plans’] investment decisions are being distorted by moral hazard, then we would expect to see less well-funded plans adopting more risky asset allocations.But this formulation is incomplete. Moral hazard could also manifest itself in pension managers who don’t believe they need to pursue a high-return (and associated high-risk) strategy because, hey, no matter how poor the investment returns are, as much money as is needed can be taken from future taxpayers – or should I say from current taxpayers, at a future time.