Two pension groups on April 21 attacked what they called “misleading impressions” in an academic paper often cited to show the severity of the nation's public pension funding problems.
Keith Brainard, research director of the National Association of State Retirement Administrators, said in a telephone interview that the 2010 study, “Public Pension Promises: How Big Are They, and What are They Worth?” comes to a conclusion that unfunded state pension liabilities total $3 trillion by using inaccurate assumptions.
The 2010 study was written by Robert Novy-Marx, assistant professor of finance at the Simon Graduate School of Business at the University of Rochester, and Joshua Rauh, an associate professor of finance at Northwestern University's Kellogg School of Management.
Mr. Brainard said the $3 trillion liability is based in part on market values as of June 30, 2009, although asset values have since grown by roughly 25%. He also said the study inaccurately uses a discount rate equal to each state's borrowing rate, which is typically 4% to 5%, instead of the state's expected rate of return, which is typically 7.5% to 8.5%.
“What they're basically saying in that $3 trillion is that a public pension fund with a diversified portfolio can be expected to return 4% to 5% over next 20 to 30 years. We believe that is an unrealistically low expectation,” Mr. Brainard said.
In a joint news release with NASRA, Ronnie Jung, president of the National Council on Teacher Retirement and executive director of the $108.2 billion Texas Teacher Retirement System, Austin, said the expected return assumption is often characterized as too generous because critics ignore long-term investment performance.
“The last 10 years have been rough ones for the capital markets and public pension funds, but public pension investment returns have actually exceeded their assumptions over the last 20- and 25-year periods,” Mr. Jung said in the release.
In a separate telephone interview, Mr. Rauh, however, said in response to the NASRA/NCTR news release that liabilities have also grown at a rate of five to six percentage points per year, adding that “the fact that they haven't mentioned that is extremely problematic.”
He said “it does not make financial sense” to use a rate to determine liabilities that exceeds the risk-free rate of 4% to 5% “if we're talking about risk-free promises the government is making.”
“Based on June 2009 values, our calculations showed over $3 trillion in unfunded pension obligations at the state and local level,” Mr. Rauh said in an e-mail. “If recent market behavior has led to increases in asset values of $500 billion, the aggregate unfunded liabilities would still be in the $2.5 trillion to $3 trillion range — even assuming stated liabilities didn't grow at all, which as I mentioned would not be in keeping with recent history.”