Passing the Disappearing Buck

Welcome to the village of La Grange, IL., where local officials hope that more than just the good among their peers do indeed die young. At least, that’s what their pension plans indicate. From the NYT:

Assuming shorter life spans reduces annual contributions and frees up money for other things, like bigger current paychecks. And if the plan bases pensions on pay, as those in most American cities do, shortening the workers’ life spans on paper could lead to both fatter paychecks now and bigger pensions in the future. […]

The recommendations made by pension actuaries, like which mortality table to use, are largely hidden from public view, but each decision ripples across decades and can have an outsize effect. More and more actuaries are now worried that their profession will be blamed for its role in steering states and cities into what is looking like a trillion-dollar quagmire.

La Grange is a microcosm of countless U.S. towns where, by some spectral mix of cronyism and ignorance, benefits have been promised that are quite simply undeliverable.

As the article states, the problem comes down to bad math. Basically, the outdated tables don’t factor in the increases in life expectancy. In La Grange, the switch to the more recent mortality tables saw the village’s minimum required contribution increase by 20 percent. At the same time, in order to keep their funded statuses within reason (often while increasing future outlays), pension funds use estimates of expected investment returns that are at best Panglossian and at worst criminally deceptive. Consider this anecdote from the piece:

He recalled seeing an assumption for future investment returns jump to 7.75 percent from 4.5 percent, with no explanation. The change lowered the state’s pension obligations by more than a billion dollars, which in turn meant smaller contributions.

To put this in context, an average diversified portfolio yielded only “a 2.6% net annualized rate of return for the 10-year time period ending Dec. 31, 2013.” The disparity between projected and actual returns is dire, and means that any estimation of pension liabilities is understated.

In the private sector, such a shuffling of assets, or passing of a disappearing buck, is known as a Ponzi scheme. Meanwhile, union bosses—who purport to care deeply and singularly about the protection of their employees—continue siphoning assets from the drying well, hoping their day of retirement comes before the day of reckoning.At some point a massive restructuring of benefits or a similarly massive, taxpayer-funded bailout will be necessary. If the latter is the case, we may need to reflect on the palatability of who is paying whom, and why. For now, pension planners will do well to live by the maxim of Wilkins Micawber: “Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”