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The Inevitable Breaking Of Impossible Promises

The impossible never happens; the inevitable always does. I say so often. It’s a prediction I feel confident repeating in many situations.

Take public pensions as an example. An article in The New York Times earlier this month discussed the disagreements among actuaries and other parties over how to calculate the value, in today’s dollars, of pensions that public-sector workers expect to receive in the future. As the article observes, governments at all levels, all over the country, have made pension promises that are impossible to meet - at least at the costs that have been disclosed to taxpayers.

Inevitably, many of those impossible promises will be broken.

The dispute is not a new development. Since the 1990s, a small but vocal group of actuaries have argued that standard practices misrepresent the true cost of public pension plans. Jeremy Gold, one such actuary cited by The Times, predicted that “When the taxpayers find out, they’re going to be absolutely furious.” In the wake of Detroit’s bankruptcy filing, a firm hired by the city’s emergency manager revealed a $3.5 million gap in Detroit’s pension system, previously presumed sound. Gold’s prediction may begin to play out shortly.

In theory, at any given level of spending, taxpayers should not care whether government employees are compensated immediately in the form of salary, or in the distant future in the form of pensions. The promised future pensions should be supported by money that is set aside today - and governments should never promise pensions that would exceed the amount that taxpayers are prepared to ante up immediately. If this were the case, today’s taxpayers, who are the ones who receive services from today’s public employees, would bear the full cost of those services without shifting any of the burden to future taxpayers or to an undefined “someone else.”

But that’s not the way it works. Public employees are human beings, and human beings favor immediate satisfaction over delayed gratification. If pensions were truly equivalent to current compensation, public employees would turn down their pensions and ask for the cash up front. Those inclined to save for their own retirement would do so; others would spend the money as they saw fit.

Instead, many states and municipalities nationwide face significant gaps between what they have promised and what they are in a position to deliver. This problem has been building for a long while; I have written about it in this space several times. Public employees are demonstrably willing to defer gratification and accept pension promises in lieu of immediate compensation.

The only reason government employees want these pensions is because their true economic value exceeds the amount that taxpayers are prepared to fork over immediately. Workers have been willing to trust that someone, ultimately, would make good on excessively optimistic promises. Public officials, in turn, have been willing to make such optimistic promises because those generous pensions induce public workers to accept less cash up front, thus concealing the true cost of today’s services from the taxpayers who enjoy them. Those taxpayers are also known as voters. If a bit of economic subterfuge keeps voters happy, politicians are more than willing to engage in it.

Since actuaries are hired to advise plans on key assumptions such as future returns, you might wonder why most of them spent so long furthering the accepted but faulty calculations that let many governments believe they had stayed in the black. The answer is simple: Actuaries are people too. They like immediate gratification as much as anyone else. Immediate gratification includes getting hired by public pension plans that are not interested in hearing that their promises are unsustainable. The Times reported that many postings for public pension actuaries explicitly exclude applicants who favor the new method of calculating obligations.

No matter how you dress it up, however, the impossible never happens. If a plan can’t keep its promises, then inevitably those promises won’t be kept. We are just at the beginning of the era of broken promises. Rest assured that Detroit’s pensioners won’t be alone.

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2 Responses to "The Inevitable Breaking Of Impossible Promises"

  • Steve Bourg, EA, MSPA
    August 5, 2013 - 4:27 pm

    Larry: I would LOVE to know the average recent pension of new retirees from NYPDrecruit.org, new retirees in 2012 let’s say, of the 42 year-olds who worked exactly 20 years to earn the ‘full’ pension. What was their ‘spiked-up’ final average pay and how much the annual pension is in 2013 (which will increase w/ COLA forever). It could well be $75,000 and if the bond rate equals cola (to get an easy present value), you’d get the present value equal to about $75,000 x 40 years for someone who lives to age 82 (which many do). that’s $3M… and what would be the contributions each year from 22 to 42 be… to accumulate to $3M at say 5% inv egns (inv earnings for last 13 1/2 years has just been about 3%/year for most balanced funds!). Answer… almost $100,000 per year for 20 years to accum to $3M. You see… the actuaries who calculate contribution rates are told to assume 7.5% or 8% inv earnings and they’re not told to expect ‘spiking’ in final year or two of working… all this ends up with egregiously large REAL costs when the final details are known!! It’s a tad more than petty-thievery from the private sector taxpayers!!!

  • Robert Tupilo
    August 6, 2013 - 1:20 pm

    Exactly. These outrageous pensions (many worth millions each – do the math and assume a 30 yr payout – esp for police and fire)

    True public sector compensation is kept hidden from view.