Big Problems with State Pension Funds

By firing its actuarial consultant last week, the New York State Legislature shone a light on one of the public sector’s deepest secrets: All across the country, states and local governments are promising benefits to public workers on the basis of numbers that make little economic sense.

The numbers are off-base for a variety of reasons. Sometimes there is a glaring conflict of interest, as there was in Albany, where the consultant was being paid by the workers seeking richer benefits. More often, there is subtle pressure on the actuary to come up with projections that make the pension fund look good.

Most of all, public pension actuaries use old methods that have fallen far out of sync with the economic mainstream. That does not necessarily mean their figures are wrong, but it does make them vulnerable to distortion, misunderstanding and abuse.

“Financial burdens have been hidden” as a result, said Jeremy Gold, a New York actuary and economist who was one of the first to call attention to the gap between actuarial figures and economic reality. Many economists now agree with Mr. Gold, saying they believe actuaries are routinely underestimating the cost of providing governmental pensions by as much as a third.

The difference “is going to come out of services, and the services are for the working poor,” Mr. Gold said.

In the private sector, pension funds are highly regulated, and actuarial numbers are less of an issue. But in government, actuaries and the consulting firms that employ them are starting to draw lawsuits in places like Alaska, San Diego, Milwaukee County, Wis., and Evanston, Ill.

In Texas, the attorney general is calling for actuaries to be registered, so the state can keep them on a shorter leash. Federal regulators are also flexing their muscles, and the actuarial rules-making board is being pushed to change.

Two big problems are being laid on actuarial doorsteps: overly aggressive investing and overly rich benefits. Benefits can go off the scale because widely used actuarial methods tend to make them look inexpensive. And this tends to encourage aggressive investing, because the greater the risk in the portfolio, the less costly it can seem to provide the benefits.

“Actuarial assumptions based on misinformation are a recipe for disaster,” said the Texas attorney general, Greg Abbott.

After the Fort Worth pension fund was found to have a crushing $410 million deficit, Mr. Abbott sent his staff to dig through more than a decade’s worth of documents, to find out why. They found that in 1990, an actuary had calculated that the city could put less money into the pension fund and increase workers’ benefits simultaneously — without making a dent in the fund — if he assumed that the fund would earn 10.23 percent a year on its investments.

This worked on paper but not in the real world. In reality, Fort Worth actually lost money on its pension investments that year. And the new benefits did, in fact, have a cost. But the city forged ahead, armed with an actuarial opinion letter stating that “the numbers are correct.” It generously sweetened public workers’ benefits five times in subsequent years.

From time to time, the actuary issued muted warnings, but he was ignored. He also began tweaking other numbers in his calculations, which kept the plan looking viable on paper. Meanwhile, the imbalances in the pension fund compounded.

“It went bust,” said David C. Mattax, the attorney general’s chief of financial litigation.

Fort Worth is now trying to come up with a reform package to bring the city pension fund back into balance. It is struggling, though, because its proposals are expensive, and some have been found unconstitutional.

Something similar happened in New Jersey. In 1994, the state needed money, and it made actuarial changes that allowed it to avoid putting billions of dollars into its pension fund. The state then spent the money on other things.

CONTINUED: In New Jersey, a deficit never closed

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