Public Sector Pension Funding Just Became Three Times More Fun

Californians have become increasingly concerned that public employee pension costs may be a future burden on taxpayers. However, due to the complex world of actuarial mathematics and lack of accounting standards, most financial geniuses could not give you a straight answer about the costs. The Government Accounting Standards Board (“GASB”), a group of “uber” accountants, is about to make pension costs a frightening surprise.

California’s irresponsible politicians just approved an $86 billion State Budget of smoke and mirrors that pushes approximately $10 billion of their $20 billion deficit to next the next administration in January. The budget fancifully estimates the current $3.8 billion cost of funding state pensions will decline. GASB’s adoption of new accounting rules next year will actually more than triple the annual cost of funding California state pensions to $12.5 billion!

Private Sector pension plans eliminated creative accounting rules still practiced by Public Sector pension plans 15 years ago. Accounting rules mandate Corporations providing employee pensions fund the expected lifetime cost of the pension over the number of years the employee will continue to work. The Private Sector concept is that the money will be “in the bank” when the employee retires, so that the pension benefits are paid in full. Public Sector pension plans have “assumed” the government is perpetual and there is no need to put enough money “in the bank” each year the Public Sector employee actually continues working before he or she retires and collects a lifetime pension benefit. Instead, actuaries have allowed the Public Sector pension plans to operate as if every person working in government will continue working for the next 30 years.

GASB calculated that the average public employee has already worked in government for 16 years. Consequently, GASB is mandating new accounting standards that will require government to put money, “in the bank” to fund lifetime pension benefit over the 14 years the average public employee will continue to work in government.

The table below reveals the startling impact this new GASB accounting rule change will have on the Public Sector pension costs. The top row demonstrates that most government pension plans assume that every dollar they contribute to a Public Sector pension plan will earn a compounded annual return of 7 % for each of the next 30 years; to generate $9.39 “in the bank” to pay pension benefits.

The middle row adjusts for the new GASB accounting rule that allows Public Sector pension plans to compound the same dollar contributed for 14 years. The GASB accounting rule change reduces the expected return from $9.39 to $2.84, a 70% reduction!

The bottom row on the table demonstrates that Public Sector pension plans will need to increase funding from $1 to $3.30 to achieve the same investment return of $9.39!

Amount Invested	Number of Years	Compound Rate of Return	Total Return
$1	30	7	$9.39
$1	14	7	$2.84
$3.30	14	7	$9.39

Most pension analysts have been suspicious of the Public Sector’s estimate that they will always achieve a compounded 7 % investment for 30 years. Warren Buffet, the Chairman of Berkshire Hathaway and a legendary successful stock market investor, has estimated his company’s long-term pension return will be 6%. The table below demonstrates Public Sector pension plan contributions would need to rise by 64% to achieve the same $9.39 return over 30 years at a 6% compounded earnings rate.

Amount Invested	Number of Years	Compound Rate of Return	Total Return
$1	30	7 %	$9.39
$1	14	6%	$5.74
$1.64	14	6%	$9.39

As you can see from the tables above, a reduction in the number of years a Public Sector pension plan compounds earnings compared to a reduction in the amount of interest earned annually; is 360% more expensive.

To put this new annual pension funding cost in human terms, the State of California will need to layoff some combination of approximately 87,000 of the state’s 310,000 teachers or 50% of the state’s 211,000 non-school employees. California taxpayers will not be alone in facing this looming nightmare, every state and local government across the United States is about to suffer the same hair raising fate.